Note: While reading a book whenever I come across something interesting, I highlight it on my Kindle. Later I turn those highlights into a blogpost. It is not a complete summary of the book. These are my notes which I intend to go back to later. Let’s start!

  • The core of strategy work is always the same: discovering the critical factors in a situation and designing a way of coordinating and focusing actions to deal with those factors.

  • Bad strategy 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 demands and interests. Like a quarterback whose only advice to teammates is “Let’s win,” bad strategy covers up its failure to guide by embracing the language of broad goals, ambition, vision, and values. Each of these elements is, of course, an important part of human life. But, by themselves, they are not substitutes for the hard work of strategy.

  • The term “strategy” should mean a cohesive response to an important challenge. Unlike a stand-alone decision or a goal, a strategy is a coherent set of analyses, concepts, policies, arguments, and actions that respond to a high-stakes challenge.

  • Strategy is about how an organization will move forward. Doing strategy is figuring out how to advance the organization’s interests.

  • A good strategy has an essential logical structure that I call the kernel. The kernel of a strategy contains three elements: a diagnosis, a guiding policy, and coherent action. The guiding policy specifies the approach to dealing with the obstacles called out in the diagnosis. It is like a signpost, marking the direction forward but not defining the details of the trip. Coherent actions are feasible coordinated policies, resource commitments, and actions designed to carry out the guiding policy.

  • Bad strategy is more than just the absence of good strategy. Bad strategy has a life and logic of its own, a false edifice built on mistaken foundations. Bad strategy may actively avoid analyzing obstacles because a leader believes 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 problem solving. Or they may avoid hard choices because they do not wish to offend anyone—generating a bad strategy that tries to cover all the bases rather than focus resources and actions.

  • The creeping spread of bad strategy affects us all. Heavy with goals and slogans, the national government has become less and less able to solve problems. Corporate boards sign off on strategic plans that are little more than wishful thinking. Our education system is rich with targets and standards, but poor in comprehending and countering the sources of underperformance. The only remedy is for us to demand more from those who lead. More than charisma and vision, we must demand good strategy.

  • The most basic idea of strategy is the application of strength against weakness. Or, if you prefer, strength applied to the most promising opportunity.

  • A good strategy doesn’t just draw on existing strength; it creates strength through the coherence of its design. Most organizations of any size don’t do this. Rather, they pursue multiple objectives that are unconnected with one another or, worse, that conflict with one another.

  • The creation of new strengths through subtle shifts in viewpoint. An insightful reframing of a competitive situation can create whole new patterns of advantage and weakness. The most powerful strategies arise from such game-changing insights.

  • The leader of an organization lacking a good strategy may simply believe that strategy is unnecessary. But more often the lack is due to the presence of bad strategy. Like weeds crowding out the grass, bad strategy crowds out good strategy. Leaders using bad strategies have not just chosen the wrong goals or made implementation errors. Rather, they have mistaken views about what strategy is and how it works.

  • In the summer of 1998, I got an opportunity to talk with Jobs again. I said, “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 Wintel standard. So what are you trying to do in the longer term? What is the strategy?” He did not attack my argument. He didn’t agree with it, either. He just smiled and said, “I am going to wait for the next big thing.” Jobs did not enunciate some simple-minded growth or market share goal. He did not pretend that pushing on various levers would somehow magically restore Apple to market leadership in personal computers. Instead, he was actually focused on the sources of and barriers to success in his industry—recognizing the next window of opportunity, the next set of forces he could harness to his advantage, and then having the quickness and cleverness to pounce on it quickly like a perfect predator. There was no pretense that such windows opened every year or that one could force them open with incentives or management tricks. He knew how it worked. He had done it before with the Apple II and the Macintosh and then with Pixar. He had tried to force it with NeXT, and that had not gone well. It would be two years before he would make that leap again with the iPod and then online music. And, after that, with the iPhone. Steve Jobs’s answer that day—“to wait for the next big thing”—is not a general formula for success. But it was a wise approach to Apple’s situation at that moment, in that industry, with so many new technologies seemingly just around the corner.

  • Having conflicting goals, dedicating resources to unconnected targets, and accommodating incompatible interests are the luxuries of the rich and powerful, but they make for bad strategy. Despite this, most organizations will 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 actions and interests. Strategy is at least as much about what an organization does not do as it is about what it does.

  • 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 only out of the corner of our minds. Not every good strategy draws on this kind of insight, but those that do generate the extra kick that separates “ordinary excellence” from the extraordinary.

  • Soft-spoken, Marshall watched my eyes, checking that I understood the implications of his statements. He took out a document, a thin sheaf of paper, and began to explain its meaning: “This document reflects thoughts about how to actually use U.S. strengths to exploit Soviet weaknesses, a very different approach.” Titled “Strategy for Competing with the Soviets in the Military Sector of the Continuing Political-Military Competition,” it had been written in 1976, near the end of the Ford administration, and bore marginal notations by President Carter’s secretary of defense, Harold Brown. It had evidently received attention. This fascinating analysis of the situation worked to redefine “defense” in new terms—a subtle shift in point of view. It argued that “in dealing effectively with the other side, a nation seeks opportunities to use one or more distinctive competences in such a way as to develop competitive advantage—both in specific areas and overall.” It then went on to explain that the crucial area of competition was technology because the United States had more resources and better capabilities in that area. And, most important, it argued that having a true competitive strategy meant engaging in actions that imposed exorbitant costs on the other side. In particular, it recommended investing in technologies that were expensive to counter and where the counters did not add to Soviet offensive capabilities. For instance, increasing the accuracy of missiles or the quietness of submarines forced the Soviet Union to spend scarce resources on counters without increasing the threat to the United States. Investments in systems that made Soviet systems obsolete would also force them to spend, as would selectively advertising dramatic new technologies. Marshall and Roche’s idea was a break with the budget-driven balance-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 exploiting the Soviets’ weaknesses. There were no complex charts or graphs, no abstruse formulas, no acronym-jammed buzz speak: just an idea and some pointers to how it might be used—the terrible simplicity of the discovery of hidden power in a situation. Their insight was framed in the language of business strategy: identify your strengths and weaknesses, assess the opportunities and risks (your opponent’s strengths and weaknesses), and build on your strengths. But the power of that strategy derived from their discovery of a different way of viewing competitive advantage—a shift from thinking about pure military capability to one of looking for ways to impose asymmetric costs on an opponent. Marshall and Roche’s analysis included a list of U.S. and Soviet strengths and 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 Marshall and Roche, like Sam Walton, had an insight that, when acted upon, provided a much more effective way to compete—the discovery of hidden power in the situation.

  • To detect a bad strategy, look for one or more of its four major hallmarks:
    • Fluff. Fluff is a form of gibberish masquerading as strategic concepts or arguments. It uses “Sunday” words (words that are inflated and unnecessarily abstruse) and apparently esoteric concepts to create the illusion of high-level thinking.
    • Failure to face the challenge. Bad strategy fails to recognize or define the challenge. When you cannot define the challenge, you cannot evaluate a strategy or improve it.
    • Mistaking goals for strategy. Many bad strategies are just statements of desire rather than plans for overcoming obstacles.
    • 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 address critical issues or when they are impracticable.

  • Bad strategy is long on goals and short on policy or action. It assumes that goals are all you need. It puts forward strategic objectives that are incoherent and, sometimes, totally impracticable. It uses high-sounding words and phrases to hide these failings.

  • 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 difficult or impossible to assess the quality of the strategy. And if you cannot assess a strategy’s quality, you cannot reject a bad strategy or improve a good one.

  • Instead of long tables of numbers and bubble charts, we have a different type of ritualized formalism for producing “strategic plans.” The current fill-in-the-blanks template starts with a statement of “vision,” then a “mission statement” or a list of “core values,” then a list of “strategic goals,” then for each goal a list of “strategies,” and then, finally, a list of “initiatives. 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 obstacles and problems that stand in the organization’s way. You will 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.”

  • “We spent about three weeks, going around to everyone, to develop these key strategies,” said Logan. “I believe in them. I believe that we can have a company that we are each proud to be part of and that is worth the effort it takes to win. There is very good buy-in on these key strategies.” “This 20/20 plan is a very aggressive financial goal,” I said. “What has to happen for it to be realized?” 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 anything it requires the will to win—the drive to succeed. The managers and staff in this company have worked hard, and the transition to digital technologies was handled well. But there is a difference between working hard and having your eye on the prize and the will to win. Sure, 20/20 is a stretch, but the secret of success is setting your sights high. We are going to get moving and keep pushing until we get there.” When I asked Logan “What has to happen?” I was looking for some point of leverage, some reason to believe this fairly quiet company could explode with growth and profit. A strategy is like a lever that magnifies force. Yes, you might be able to drag a giant block of rock across the ground with muscles, ropes, and motivation. But it is wiser to build levers and wheels and then move the rock. I tried again: “Chad, when a company makes the kind of jump in performance your plan envisions, there is usually a key strength you are building on or a change in the industry that opens up new opportunities. Can you clarify what the point of leverage might be here, in your company?” Logan frowned and pressed his lips together, expressing frustration that I didn’t understand his meaning. He pulled a sheet of paper out of his briefcase and ran a finger under the highlighted text. “This is what Jack Welch says,” he told me. The text read: “We have found that by reaching for what appears to be the impossible, we often actually do the impossible.” “That’s what we are going to do here,” said Logan. I didn’t think that Logan’s concept of his 20/20 goal was a useful way to proceed. Strategic objectives should address a specific process or accomplishment, such as halving the time it takes to respond to a customer, or getting work from several Fortune 500 corporations. However, arguing with him at that juncture wouldn’t have been productive. I met with Chad Logan a few days after our first get-together. I told him that I would explain my point of view and then let him decide whether he wanted to work with me on strategy. I said: I think you have a lot of ambition, but you don’t have a strategy. I don’t think it would be useful, right now, to work with your managers on strategies for meeting the 20/20 goal. What I would advise is that you first work to discover the very most promising opportunities for the business. Those opportunities may be internal, fixing bottlenecks and constraints in the way people work, or external. To do this, you should probably pull together a small team of people and take a month to do a review of who your buyers are, who you compete with, and what opportunities exist. It’s normally a good idea to look very closely at what is changing in your business, where you might get a jump on the competition. You should open things up so there are as many useful bits of information on the table as possible. If you want, 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 aimed at channeling energy into what seem to be one or two of the most attractive opportunities, where it looks like you can make major inroads or breakthroughs. I can’t tell you in advance how large such opportunities are, or where they may be. I can’t tell you in advance how fast revenues will grow. Perhaps you will want to add new services, or cut back on doing certain things that don’t make a profit. Perhaps you will find it more promising to focus on grabbing the graphics work that currently goes in-house, rather than to competitors. But, in the end, you should have a very short list of the most important things for the company to do. Then you will have a basis for moving forward. That is what I would do were I in your shoes. If you continue down the road you are on you will be counting on motivation to move the company forward. I cannot honestly recommend that as a way forward because business competition is not just a battle of strength and wills; it is also a competition over insights and competencies. My judgment is that motivation, by itself, will not give this company enough of an edge to achieve your goals. Chad Logan thanked me and, a week later, retained someone else to help him. The new consultant took Logan and his department managers through an exercise he called “Visioning.” The gist of it was the question “How big do you think this company can be?” In the morning they stretched their aspirations from “bigger” to “very much bigger.” Then, in the afternoon, the facilitator challenged them to an even grander vision: “Think twice as big as that,” he pressed. Logan was pleased. I was pleased to be elsewhere engaged. Chad Logan’s “key strategies” had little to do with strategy. They were simply performance goals. This same problem affects many corporate “strategy plans.” Business leaders know their organizations should have a strategy. Yet many express frustration with the whole process of strategic planning. The reason for this dissatisfaction is that most corporate strategic plans are simply three-year or five-year rolling budgets combined with market share projections. Calling a rolling budget of this type a “strategic plan” gives people false expectations that the exercise will somehow result in a coherent strategy. There is nothing wrong with planning. It is an essential part of management. Take, for example, a rapidly growing retail chain. It needs a plan to guide property acquisition, construction, training, and so on. This is 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 resource activities, the opening and expansion of offices in various regions, and its financing policies. You can call these annual exercises “strategic planning” if you like, but they are not strategy. They cannot deliver what senior managers want: a pathway to substantially higher performance. To obtain higher performance, leaders must identify the critical obstacles to forward progress and then develop a coherent approach to overcoming them. This may require product innovation, or new approaches to distribution, or a change in organizational structure. Or it may exploit insights into the implications of changes in the environment—in technology, consumer tastes, laws, resource prices, or competitive behavior. The leader’s responsibility is to decide which of these 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. The need for true strategy work is episodic, not necessarily annual.

  • Being a general manager, CEO, president, or other top-level leader means having more power and being less constrained. Effective senior leaders don’t chase arbitrary goals. Rather, they decide which general goals should be pursued. And they design the subgoals that various pieces of the organization work toward. Indeed, the cutting edge of any strategy is the set of strategic objectives (subgoals) it lays out. One of the challenges of being a leader is mastering this shift from having others define your goals to being the architect of the organization’s purposes and objectives. To help clarify this distinction it is helpful to use the word “goal” to express overall values and desires and to use the word “objective” to denote 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’s most important job is creating and constantly adjusting this strategic bridge between goals and objectives.

  • For example, Chen Brothers was a rapidly growing regional distributor of specialty foods. Its overall goals included growing profit, being a good place to work, and being seen as the go-to distributor for organic foods. These were all worthy goals. None of them, however, implied a particular strategy or action, although they can be seen as constraints (that is, these sorts of broad “goals” work like the rules of football in that they rule out a great many actions without specifying what the team should actually do). Chen Brothers’ strategy had been to target local specialty retailers that would pay a price premium to carry distinctive products not available at the large chain stores. Top management had divided its customers and potential customers into three tiers and set strategic objectives for each tier. The most important objectives were shelf-space dominance in the top tier, promotional parity or better in the middle tier, and growing penetration in the lowest tier. The recent rapid growth of Whole Foods was putting increasing pressure on the local specialty shops that had been Chen Brothers’ target market. Accordingly, management was formulating a new strategy of linking together small local food producers under a common brand that could be sold through Whole Foods. This change in strategy had no impact on the company’s overall goals, but clearly meant a radical restructuring of its current strategic objectives. Instead of penetration objectives for different classes of retailers, Chen Brothers put together a “Whole Foods” team that combined production, marketing, advertising, distribution, and financial expertise. The team was entirely focused on the objective of making Chen Brothers’ most distinctive new product a national account at Whole Foods. Once that was accomplished, further objectives concerning other products, shelf space, and market share would be set. Chen Brothers did not fall into the trap of believing that strategy is a grand vision or a set of financial goals. Instead, management had skillfully designed a “way forward” that concentrated corporate attention on one or two important objectives. Once accomplished, new opportunities would open up and more ambitious objectives could be set.

  • Good strategy works by focusing energy and resources on one, or a very few, pivotal objectives whose accomplishment will lead to a cascade of favorable 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,” is not a strategy. It is just a list of things to do. Such lists usually grow out of planning meetings in which a wide variety of stakeholders make suggestions as to things they would like to see done. Rather than focus on a few important items, the group sweeps the whole day’s collection into the “strategic plan.” Then, in recognition that it is a dog’s dinner, the label “long-term” is added so that none of them need be done today. The second form of bad strategic objectives is one that is “blue sky.” A good strategy defines a critical challenge. What is more, it builds a bridge between that challenge and action, between desire and immediate objectives that lie within grasp. Thus, the objectives a good strategy sets should stand a good chance of being accomplished, given existing resources and competence. By contrast, a blue-sky objective is usually a simple restatement of the desired state of affairs or of the challenge. It skips over the annoying fact that no one has a clue as to how to get there. A leader may successfully identify the key challenge and propose an overall approach to dealing with the challenge. But if the consequent strategic 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. If the leader’s strategic objectives are just as difficult to accomplish as the original challenge, there has been little value added by the strategy.

  • In 2006, David Brewer, a former admiral in the U.S. Navy, took the job of superintendent of the giant Los Angeles Unified School District (LAUSD). His daunting assignment was to make a difference in the nation’s largest school district. In California, schools are measured in terms of a statewide aggregate test 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. Department of Education’s No Child Left Behind goals. Soon after reviewing the situation, Brewer defined the challenge as making a significant improvement in the test performance scores at the district’s 34 weakest schools: 17 middle and 17 high schools he termed “high priority.” His idea was to work on improving these 34 weakest schools first, but to then build on success by expanding efforts to the rest of the system. Brewer deserves credit for creating a strategy with a focus—the thirty-four high-priority schools that had been the consistently worst performing on the API tests. By focusing on the lowest performing 34 of 991 schools, there was the opportunity to break with the past and with the many-layered system of regulation, union control, and grossly oversized central administration. Indeed, it might have been reasonable to decide that this challenge, by itself, was worth being the single keystone of the strategy. By zeroing in on this one critical issue something might have been accomplished. Still, it is worth noting that this definition of “performance” was itself “strategic” in an unpleasant way. Using API test scores sidestepped LAUSD’s horrendous dropout rate, especially among black and Hispanic students who together form the overwhelming majority of students in Los Angeles (13 and 70 percent respectively). Of black students entering LAUSD high schools, 33 percent dropped out. Of Hispanics, 28 percent dropped out. The terrible truth was that one way to increase a school’s API score was to encourage the weakest students to drop out—the API measured only active students. When a leader characterizes the challenge as underperformance, it sets the stage for bad strategy. Underperformance is a result. The true challenges are the reasons for the underperformance. Unless leadership offers a theory of why things haven’t worked in the past, or why the challenge is difficult, it is hard to generate good strategy. One of Brewer’s seven key strategies was to “build school and District leadership teams that share common beliefs, values, and high expectations for all adults and students and that support a cycle of continuous improvement to ensure high-quality instruction in their schools.” This would be accomplished by building the “capacity of administrative and other school leaders.Transformational leaders need a strongly focused program to define, sharpen and apply critical skill sets in their everyday work.” This strategy/objective is “bad” in several respects. First, there is no diagnosis of the reasons that leadership is weak and expectations are low. A serious look at this issue would reveal that the high-priority schools had been failing for decades. A system spending $25,000 per student per year and that 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 decades to remedy the system and has not. Second, it is an absurdly blue-sky objective to ask for “transformational leadership” when (1) the text of the plan explains that many administrators and leaders have limited ability to meet their daily problems, (2) no one knows how to create “transformational” leaders even in the best of conditions, and (3) these schools remain embedded in a giant all-controlling bureaucracy and union system. The so-called transformational leaders cannot change the 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. The proposed solutions—lots of coordination up and down the hierarchy, time off, and in-house training—are woefully inadequate and illustrate the system’s wasteful self-serving sclerosis. An interesting aspect of this language is the idea that leadership teams must share common beliefs and values. This is now a frequent demand in education circles. One would hope that the experience of North Korea would have cured 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 “transformational change.” Another “strategy” was to “build at each school a community of informed and empowered parents, teachers, staff, and community partners who work collaboratively to support high-quality teaching and learning.” In particular, the plan called for the creation of a “community liaison” position, mandating monthly meetings, twice-a-year parent conferences, and a parent volunteer program. A high rate of community involvement might be a very desirable state of 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 deepens as students grow older. A principal cause of this underperformance is the poverty-stricken chaotic communities these schools serve. In the LAUSD, many students are illegal immigrants or the children of illegal immigrants. Names and addresses are often fictitious, and parents may be unwilling to sign up for school programs. Many students are the children of teen mothers who never finished their own educations, don’t read books themselves, and have little free time or energy, spending hours each day commuting to and from low-paying jobs. These are the kinds of true challenges a good strategy would have to recognize.

  • Bad strategy is vacuous and superficial, has internal contradictions, and doesn’t define or address the problem. Bad strategy generates a feeling of dull annoyance when you have to listen to it or read it.

  • 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 fundamentals and the difficulties of mastering them. Not miscalculation, bad strategy is the active avoidance of the hard work of crafting a good strategy. One common reason for choosing avoidance is the pain or difficulty of choice. When leaders are unwilling or unable to make choices among competing values and parties, bad strategy is the consequence. A second pathway to bad strategy is the siren song of template-style strategy—filling in the blanks with vision, mission, values, and strategies. This path 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.

  • Strategy involves focus and, therefore, choice. And choice means setting aside some goals in favor of others. When this hard work is not done, weak amorphous strategy is the result.

  • DEC’s chief executive, Ken Olsen, had made the mistake of asking the group to reach a consensus. The group was unable to do that because there was no basis in logic or hierarchy to reject a subgroup’s passionately held positions. Instead, the group compromised on a statement like this: “DEC is committed to providing high-quality products and services and being a leader in data processing.” This fluffy, amorphous statement was, of course, not a strategy. It was a political outcome reached by individuals who, forced to reach a consensus, could not agree on which interests and concepts to forgo. So they avoided the hard work of choice, set nothing aside, hurt no interest groups or individual egos, but crippled the whole.

  • Serious strategy work in an already successful organization may not take place until the wolf is at the door—or even until the wolf’s claws actually scratch on the floor—because good strategy is very hard work. At DEC, the wolf was at the door in 1988, but still the hard work of combining the knowledge and judgments of people with different backgrounds and talents was sidestepped. When the wolf finally broke into the house itself, one point of view won and pressed aside the others. By then, it was five years too late to matter.

  • There has been a lot of ink spilled on the inner logic of competitive strategy and on the mechanics of advantage. But the essential difficulty in creating strategy is not logical; it is choice itself. Strategy does not eliminate scarcity and its consequence—the necessity of choice. Strategy is scarcity’s child and to have a strategy, rather than vague aspirations, is to choose one path and eschew others. There is difficult psychological, political, and organizational work in saying “no” to whole worlds of hopes, dreams, and aspirations. When a strategy works, we tend to remember what was accomplished, not the possibilities that were painfully set aside.

  • Any coherent strategy pushes resources toward some ends and away from others. These are the inevitable consequences of scarcity and change. Yet this channeling of resources away from traditional uses is fraught with pain and difficulty. Intel CEO Andy Grove vividly relates the intellectual, emotional, and political difficulties in moving the company from producing dynamic random access memory (DRAM) to one focused on microprocessors. Intel was known as a memory company and had developed much of the complex technology required to design and manufacture chips. But by 1984 it 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 when he gloomily asked Intel’s chairman, Gordon Moore, “If we got kicked out and the board brought in a new CEO, what do you think he would do?” 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 walk out the door, come back and do it ourselves?”

  • Even after forming that conviction, it took over a year to make the change. The memory business had been the engine that drove research, production, careers, and pride at Intel. Salespeople worried about customer response, and researchers resisted the cancellation of memory-based projects. Grove pushed through the exit from the memory business and refocused the company on microprocessors. The success of the new 32-bit 386 chips propelled Intel into being the world’s largest semiconductor company by 1992.

  • Strategies focus resources, energy, and attention on some objectives rather than others. Unless collective ruin is imminent, a change in strategy will make some people worse off. Hence, there will be powerful forces opposed to almost any change in strategy. This is the fate of many strategy initiatives in large organizations. There may be talk about focusing on this or pushing on that, but at the end of the day no one wants to change what they are doing very much. When organizations are unable to make new strategies—when people evade the work of choosing among different paths into the future—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 usually signals the absence of choice.

  • In organizations and politics, the longer a pattern of activity is maintained, the more it becomes entrenched and the more its supporting resource allocations are taken to be entitlements. Compare, for example, the inertia in today’s national security apparatus with that experienced by Presidents Truman and Eisenhower. During Eisenhower’s administration, the Defense Department, an independent air force, the CIA, the National Security Council, and NATO were all newly created. Because new structures are more malleable, President Eisenhower had enough power to reshape their missions and induce some coordination with the Department of State. But today, after more than half a century, the power required to reshape and compel coordination among these organizations is many times greater than Eisenhower ever used. It would take enormous political will and the exercise of great centralized power to overcome the present levels of institutional resistance to change. Such power is, of course, possible, but it would take a crisis of epic proportions to engender it.

  • Leadership and strategy may be joined in 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 worth pursuing and capable of being accomplished.

  • A great deal of strategy work is trying to figure out what is going on. Not just deciding what to do, but the more fundamental problem of comprehending the situation. At a minimum, a diagnosis names or classifies the situation, linking facts into patterns and suggesting that more attention be paid to some issues and less to others. An especially insightful diagnosis can transform one’s view of 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, making the diagnosis an explicit element of the strategy allows the rest of the strategy to be revisited and changed as circumstances change.

  • Consider Starbucks, which grew from a single restaurant to an American icon. In 2008, Starbucks was experiencing flat or declining same-store traffic growth and lower profit margins, its return on assets having fallen from a generous 14 percent to about 5.5 percent. An immediate question arose: 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. Slowing growth is a problem for Wall Street but is a natural stage in the development of any noncancerous entity. Although the U.S. market may have been saturated, were there still opportunities for expansion abroad? Deutsche Bank opined that Starbucks faced a great deal of competition oversees, noting in particular that its 23 remaining restaurants in Australia competed with 764 McDonald’s outlets selling McCafe-branded coffee, lattes, cappuccinos, and smoothies. By contrast, Oppenheimer opined, “We would expect that these markets [Europe] are still under-penetrated enough to maintain growth.” Was the foreign market saturated? Or were there more serious problems? Was overbuilding outlets a sign of poor management? Were consumers’ tastes changing once again? As competitors improved their coffee offerings, was Starbucks’ differentiation vanishing? In fact, how important for Starbucks was the coffee-shop setting it provided versus the coffee itself? Was Starbucks a coffee restaurant, or was it actually an urban oasis? Could its brand be stretched to other types of products and even other types of restaurants? At Starbucks, one executive might diagnose this challenging situation as “a problem in managing expectations.” Another might diagnose it as “a search for new growth platforms.” A third might diagnose it as “an eroding competitive advantage.” None of these viewpoints is, by itself, an action, but each suggests a range of things that might be done and sets aside other classes of action as less relevant to the challenge. Importantly, none of these diagnoses can be proven to be correct—each is a judgment about which issue is preeminent. Hence, diagnosis is a judgment about the meanings of facts. The challenge facing Starbucks was ill-structured. By that I mean that no 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 outcomes were unclear. Because the challenge was ill-structured, a real-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, especially about what was critically important. The diagnosis for the situation should replace the overwhelming complexity of reality with a simpler story, a story that calls attention to its crucial aspects. This simplified model of reality allows one to make sense of the situation and engage in further problem solving. Furthermore, a good strategic diagnosis does more than explain a situation—it also defines a domain of action. Whereas a social scientist seeks a diagnosis that best predicts outcomes, good strategy tends to be based on the diagnosis promising leverage over outcomes.

  • In business, most deep strategic changes are brought about by a change in 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 company was in serious decline. Its historically successful strategy had been organized around offering complete, integrated, turnkey end-to-end computing solutions to corporations and government agencies. However, the advent of the microprocessor changed all that. The computer industry began to fragment, with separate firms offering chips, memory, hard disks, keyboards, software, monitors, operating systems, and so on. As computing moved to the desktop, and as IBM’s desktop offering became commoditized by clone competitors and the Windows-Intel standard, what should the company do? The dominant view at the company and among Wall Street analysts was that IBM was too integrated. The new industry structure was fragmented and, it was argued, IBM should be broken up and fragmented to match. As Gerstner arrived, preparations were under way for separate stock offerings for various pieces of IBM. After studying the situation, Gerstner changed the diagnosis. He believed that in an increasingly fragmented industry, IBM was the one company that had expertise in all areas. Its problem was not that it was integrated but that it was failing to use the integrated skills it possessed. IBM, he declared, needed to become more integrated—but this time around customer solutions rather than hardware platforms. The primary obstacle was the lack of internal coordination and agility. Given this new diagnosis, the guiding policy became to exploit the fact that IBM was different, in fact, unique. IBM would offer 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 hardware to software. Neither the “integration is obsolete” nor the “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 different directions.

  • The guiding policy outlines an overall approach for overcoming the obstacles 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’ problems are examples of guiding policies. Like the guardrails on a highway, the guiding policy directs and constrains action without fully defining its content. Good guiding policies are not goals or visions or images of desirable end states. Rather, they define a method of grappling with the situation and ruling out a vast array of possible actions. For example, Wells Fargo’s corporate vision is this: “We want to satisfy all of our customers’ financial needs, 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.” This “vision” communicates an ambition, but it is not a strategy or a guiding policy because there is no information about how this ambition will be accomplished. Wells Fargo chairman emeritus and former CEO Richard Kovacevich knew this and distinguished between this vision and his company’s guiding policy of using the network effects of cross-selling. That is, Kovacevich believed that the more different financial products Wells Fargo could sell to a customer, the more the company would know about that customer and about its whole network of customers. That information would, in turn, help it create and sell more financial products. This guiding policy, in contrast to Wells Fargo’s vision, calls out a way of competing—a way of trying to use the company’s large scale to advantage.

  • You may correctly observe that many other people use the term “strategy” for what I am calling the “guiding policy.” I have found that defining a strategy as just a broad guiding policy is a mistake. Without a diagnosis, one cannot evaluate alternative guiding policies. Without working through to at least the first round of action one cannot be sure that the guiding policy can be implemented. Good strategy is not just “what” you are trying to do. It is also “why” and “how” you are doing it. A good guiding policy tackles the obstacles identified in the diagnosis by creating or drawing upon sources of advantage. Indeed, the heart of the matter in strategy is usually advantage. Just as a lever uses mechanical advantage to multiply force, strategic advantage multiplies the effectiveness of resources and/or actions. Importantly, not all advantage is competitive. In nonprofit and public policy situations, good strategy creates advantage by magnifying the effects of resources and actions. In most modern treatments of competitive strategy, it is now common to launch immediately into detailed descriptions of specific sources of competitive advantage. Having lower costs, a better brand, a faster product-development cycle, more experience, more information about customers, and so on, can all be sources of advantage. This is all true, but it is important to take a broader perspective. A good guiding policy itself can be a source of advantage. A guiding policy creates advantage by anticipating the actions and reactions of others, by reducing the complexity and ambiguity in the situation, by exploiting the leverage inherent in concentrating effort on a pivotal or decisive aspect of the situation, and by creating policies and actions that are coherent, each building on the other rather than canceling one another out.

  • For example, Gerstner’s “provide customer solutions” policy certainly counted on the advantages implicit in IBM’s world-class technological depth and expertise in almost all areas of data processing. But the policy itself also created advantage by resolving the uncertainty about what to do, about how to compete, and about how to organize. It also began the process of coordinating and concentrating IBM’s vast resources on a specific set of challenges.

  • To look more closely at how a guiding policy works, follow the thinking of Stephanie, a friend who owns a corner grocery store. She does the accounts, manages personnel, sometimes runs the cash register, and makes all the decisions. Several years ago, Stephanie told me about some of the issues she was facing. She was considering whether she should keep prices down or offer more expensive, fresh organic produce. Should she begin to stock more Asian staples for the many Asian students who lived in the area? Should the store be open longer hours? How important was it to have a helpful, friendly staff that gets to know the regulars? Would adding a second checkout stand pay off? What about parking in the alley? Should she advertise in the local college newspaper? Should she paint the ceiling green or white? Should she put some items on sale each week? Which ones? An economist would tell her that she should take actions that maximize profit, a technically correct but useless piece of advice. In the economics textbook it is simple: choose the rate of output Q that provides the biggest gap between revenue and cost. In the real world, however, “maximize profit” is not a helpful prescription, because the challenge of making, or maximizing, profit is an ill-structured problem. Even in a corner grocery store, there are hundreds or thousands of possible adjustments one can make, and millions in a business of any size—the complexity of the situation can be overwhelming. Thinking about her store, Stephanie diagnosed her challenge to be competition with the local supermarket. She needed to draw customers away from a store that was open 24/7 and had lower prices. Seeking a way forward, she believed that most of her customers were people who walked by the store almost every day. They worked or lived nearby. Scanning her list of questions and alternatives, she determined that there was a choice between serving the 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 dramatic reduction in complexity. Of course, if both of these customer segments could be served with the same policies and actions, then the dichotomy would have been useless and should be cast aside. In Stephanie’s case, the difference seemed significant. More of her customers were students, but the professionals who stopped in made much larger purchases. Pushing further along, Stephanie began to explore the guiding policy of “serve the busy professional.” After some more tinkering, Stephanie sharpened the guiding policy a bit more, deciding to target “the busy professional who has little time to cook.” There was no way to establish that this particular guiding policy was the only good one, or the best one. But, absent a good guiding policy, there is no 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 professional with little time to cook, she could see that the second checkout stand would help handle the burst of traffic at 5 p.m. So would more parking in the alley. In addition, she felt she could take space currently used for selling munchies to students and offer prepared high-quality take-home foods instead. Professionals, unlike students, would not come shopping at midnight, so there was no need for very late hours. The busy professionals would appreciate adequate staffing after work and, perhaps, at lunchtime. Having a guiding policy helped create actions that were coordinated and concentrated, focusing her efforts.

  • Many people call the guiding policy “the strategy” and stop there. This is a mistake. Strategy is about action, about doing something. The kernel of a strategy must contain action. It does not need to point to all the actions that will be taken as events unfold, but there must be enough clarity about action to bring concepts down to earth. To have punch, actions should coordinate and build upon one another, focusing organizational energy.

  • In many situations, the main impediment to action is the forlorn hope that certain painful choices or actions can be avoided—that the whole long list of hoped-for “priorities” can all be achieved. It is the hard craft of strategy to decide which priority shall take precedence. Only then can action be taken. And, interestingly, there is no greater tool for sharpening strategic ideas than the necessity to act.

  • The actions within the kernel of strategy should be coherent. That is, the resource deployments, policies, and maneuvers that are undertaken should be consistent and coordinated. The coordination of action provides the most basic source of leverage or advantage available in strategy. In a fight, the simplest strategy is a feint to the left and then punch from the right, a coordination of movement in time and space. The simplest business strategy is to use knowledge gleaned by sales and marketing specialists to affect capacity expansion or product design decisions—coordination across functions and knowledge bases. Even when an organization has an apparently simple and basic source of advantage, such as being a low-cost producer, a close examination will always reveal a raft of interrelated mutually supporting policies that, in this case, keep costs low. Furthermore, it will be found that these costs are lower only for a certain type of products delivered under certain conditions. Using such a cost advantage to good effect will require the alignment of many actions and policies. 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 profits in the automobile industry.” Moving into the corporate CEO spot in 1999, Nasser quickly acted to acquire Volvo, Jaguar, Land Rover, and Aston Martin. However, at the same time, the company’s original guiding policy of “economies of scale” was fully alive and kicking. A senior Ford executive told me in 2000: “You cannot be competitive in the automobile industry unless you produce at least one million units per year on a platform.” Thus, the actions of buying Volvo and Jaguar were conjoined with actions designed to put both brands on a common platform. Putting Jaguar and Volvo on the same platform dilutes the brand equity of both marques and annoys the most passionate customers, dealers, and service shops. Volvo buyers don’t want a “safe Jaguar”; they want a car that is uniquely safe. And Jaguar buyers want something more distinctive than a “sporty Volvo.” These two sets of concepts and actions were in conflict rather than being coherent.

  • What about a list of nonconflicting but uncoordinated actions? In 2003, I worked with a company whose initial “strategy” was to (1) close a plant in Akron and open a new plant in Mexico, (2) spend more on advertising, and (3) initiate a 360-degree feedback program. Now these actions may all have been good ideas, but they did not complement one another. They are “strategic” only in the sense that each probably requires the approval of top management. My view is that doing these things might be sound operational management, but it did not constitute a strategy. A strategy coordinates action to address a specific challenge. It is not defined by the pay grade of the person authorizing the action. The idea that coordination, by itself, can be a source of advantage is a very deep principle. It is often underappreciated because people tend to think 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.

  • Another powerful way to coordinate actions is by the specification of a proximate objective. By “proximate,” I mean a state of affairs close enough at hand to be feasible. If an objective is clear and feasible, it can help coordinate both problem solving and direct action.

  • Strategy is visible as coordinated action imposed on a system. When I say strategy is “imposed,” I mean just that. It is an exercise in centralized power, used to overcome the natural workings of a system. This coordination is unnatural in the sense that it would not occur without the hand of strategy.

  • The potential gains to coordination do not mean that more centrally directed coordination is always a good thing. Coordination is costly, because it fights against the gains to specialization, the most basic economies in organized activity. To specialize in something is, roughly speaking, to be left alone to do just that thing and not be bothered with other tasks, interruptions, and other agents’ agendas. As is clear to anyone who has belonged to a coordinating committee, coordination interrupts and de-specializes people. 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 maladaptive stasis. Good strategy and good organization lie in specializing on the right activities and imposing only the essential amount of coordination.

  • A good strategy works by harnessing power and applying it where it will have the greatest effect. In the short term, this may mean attacking a problem or rival with adroit combinations of policy, actions, and resources. In the longer term, it may involve cleverly using policies and resource commitments to develop capabilities that will be of value in future contests. In either case, a “good strategy” is an approach that magnifies the effectiveness of actions by finding and using sources of power.

  • 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.

  • Strategic leverage arises from a mixture of anticipation, insight into what is most pivotal or critical in a situation, and making a concentrated application of effort.

  • The strategist may have insight into predictable aspects of others’ behavior that can be turned to advantage. At the simplest level, a strategy of investing in Manhattan real estate is based on the anticipation that other people’s future demand for this real estate will raise its value. In competitive strategy, the key anticipations are often of buyer demand and competitive reactions. As an example of anticipation, while the SUV craze was booming in the 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 hybrid vehicles a major product category. Second, management believed that, once presented with the chance to license Toyota’s technology, other automakers would do so and not invest in developing possibly superior systems. Thus far, both anticipations have proven reasonably accurate.

  • Most strategic anticipation draws on the predictable “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 follow that make aspects of their behavior predictable.

  • To achieve leverage, the strategist must have insight into a pivot point that will magnify the effects of focused energy and resources. As an example of a pivotal objective, in 2008 I was in Tokyo, discussing competitive strategy with Noritoshi Murata, the president and chief operating officer of Seven & i Holdings. This company owns all of the 7-Eleven convenience stores in the United States and Asia, as well as grocery superstores and department stores in Japan and other ventures. Focusing on Japan, Murata explained that the company had come to the conclusion that Japanese customers were extremely sensitive to variations in local tastes and fond of both newness and variety. “In Japan,” he told me, “consumers are easily bored. In soft drinks, for example, there are more than two hundred soft-drink brands and lots of new ones each week! A 7-Eleven displays fifty varieties with a turnover of seventy percent each year. The same holds true in many food categories.” To create leverage around this pattern, 7-Eleven Japan has developed a method of collecting information from store managers and employees about local tastes and forming quick-response merchandising teams to develop new product offerings. To further leverage this information and team skills, the company has developed relationships with a number of second- and third-tier food manufacturers and found ways to quickly bring new offerings to market under its own private-label brand, at low prices, using the food manufacturers’ excess capacity. At the same time, 7-Eleven was expanding its operations in China. There, Murata explained, their outstanding advantage was cleanliness and service. The Chinese consumers were used to being supplicants at a retail outlet, and 7-Eleven Japan’s tradition of spotless interiors and white-gloved service personnel who greeted customers with bows and smiles, as well as its good-tasting lunches, were producing twice as many sales per square foot than any competitor obtained. Murata’s strategy focused organizational energy on decisive aspects of the 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 create and extend advantage.

  • A pivot point magnifies the effect of effort. It is a natural or created imbalance in a situation, a place where a relatively small adjustment can unleash much larger pent-up forces. The business strategist senses such imbalances in pent-up demand that has yet to be fulfilled or in a robust competence developed in one context that can be applied to good effect in another. In direct rivalry, the pivot point may be an imbalance between a rival’s position or disposition of forces and their underlying capabilities, or between pretension and reality. On June 12, 1987, President Reagan stood at the Brandenburg Gate in West Berlin and said: “General Secretary Gorbachev, 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, open this gate! Mr. Gorbachev, tear down this wall!” Of course, Reagan did not expect Gorbachev to do any such thing. The speech was directed to Western Europeans, and its purpose was to highlight, and thereby exploit, the imbalance between a system that allowed the free movement of people with one that had to restrain its citizens with barbed wire and concrete. That imbalance had existed for decades. Had Reagan given a similar challenge to Yuri Andropov in 1983, it would have had little effect. It became a pivot point because of the extra imbalance between Mikhail Gorbachev’s claim that the Soviet Union was liberalizing and the facts on the ground.

  • 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, there would be no need to select one objective over another. If rivals could easily see our moves and quickly mobilize responses, we would gain little from concentrating on temporary weaknesses. If senior leadership did not have limited cognition, they would gain nothing from concentrating their attention on a few priorities. A “threshold effect” exists when there is a critical level of effort necessary to affect the system. Levels of effort below this threshold have little payoff. When there are threshold effects, it is prudent to limit objectives to those that can be affected by the resources at the strategist’s disposal. For example, there seems to be a threshold effect in advertising. That is, a very small amount of advertising will produce no result at all. One has to get over this hump, or threshold, to start getting a response to advertising efforts. This means it may pay companies to pulse their advertising, concentrating it into relatively short periods of time, rather than spreading it evenly. It may also make sense for a company to roll out a new product region by region, concentrating its advertising where the product is new so as to spur adoption. Due to similar forces, business strategists will often prefer to dominate a small market segment over having an equal number of customers who represent only a sliver of a larger market. Politicians will often prefer a plan that delivers a clear benefit to a recognizable group over one that provides larger benefits spread more thinly across the population. Within organizations, some of the factors giving rise to concentration are the substantial threshold effects in effecting change and the cognitive and attention limits of the senior management group. Just as an individual cannot solve five problems at once, most organizations concentrate on a few critical issues at any one time. From a psychological perspective, there can be returns to focus or concentration when people ignore signals below a certain threshold (called a “salience effect” in psychology) or when they believe in momentum—that success leads to success. In either case, the strategist can increase the perceived effectiveness of action by focusing effort on targets that will catch attention and sway opinion. It may, for example, have more impact on public opinion to completely turn around two schools than to make a 2 percent improvement in two hundred schools. In turn, peoples’ perceptions of efficacy affect their willingness to support and take part in further actions.

  • One of a leader’s most powerful tools is the creation of a good proximate objective—one that is close enough at hand to be feasible. A proximate objective names a target that the organization can reasonably be expected to hit, even overwhelm. For example, President Kennedy’s call for the United States to place a man on the moon by the end of the 1960s is often held out as a bold push into the unknown. Along with Martin Luther King Jr.’s “I Have a Dream” 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 chosen proximate strategic objective.

  • Every organization faces a situation where the full complexity and ambiguity of the situation is daunting. An important duty of any leader is to absorb a large part of that complexity and ambiguity, passing on to the organization a simpler problem—one that is solvable. Many leaders fail badly at this responsibility, announcing ambitious goals without resolving a good chunk of ambiguity about the specific obstacles to be overcome. To take responsibility is more than a willingness to accept the blame. It is setting proximate objectives and handing the organization a problem it can actually solve.

  • The more uncertain and dynamic the situation, the more proximate a strategic objective must be. 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 position and creating options,” not of looking far ahead.

  • In 2005, I was invited to help a smaller business school with its strategic plan. Business schools teach strategy but rarely apply the concept to themselves. At this school, the overall ambition of the dean and faculty was to break out from being a local school to one ranked with the best in the region. The draft strategic plan was typical for the industry: it was a list of areas in which the school would announce initiatives and try harder. It called for increased research visibility, more alumni giving, the creation of a global business studies program, the enhancement of its entrepreneurial studies program, and a sustainability initiative. Looking more closely at the situation, one could see that the largest segment of students took jobs in accounting firms and small-to-medium-sized local service businesses. Strategic planning was the responsibility of the dean and the faculty executive council. I met with this group and explained the concepts of pivotal issues and the proximate objective. Then I asked the group to imagine that they were allowed to have only one objective. And the objective had to be feasible. What one single feasible objective, when accomplished, would make the biggest difference? After a morning’s deliberation they had two. They weren’t quite as feasible as I would have liked, but they were a big step forward from their vague ambition to be a top school in the region. About one-half of the group had come up with an obvious, yet potentially pivotal, objective: “getting the students into better jobs.” If students got better jobs, it was argued, they would be happier, faculty would be happier teaching happier students, alumni would give more money to the school, better students would be attracted to the school, and more resources would flow into the school to fund research and hiring. The other half of the group was in favor of a public-relations objective. They believed that focusing on getting more coverage of the school in business magazines and newspapers would raise its profile, yielding a number of favorable results. Importantly, both objectives represented strong positions within a field of action and were each pregnant with options for future strategizing and action. I praised both objectives and asked the group to make either or both even more proximate—more like tasks and less like goals. By the end of the day, 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 presently were not. Faculty committees would be created to study these firms’ recruiting practices and create programs to meet their needs and standards. Secondly, instead of global studies and sustainability, the school committed itself to a new course of studies on media management. The idea was that such a program would attract media people to visit the school, and if students got jobs in the media, it would naturally help raise the school’s profile. Two of the ten target firms would be media companies.

  • A system has a chain-link logic when its performance is limited by its weakest subunit, or “link.” When there is a weak link, a chain is not made stronger by strengthening the other links. For the space shuttle Challenger, the weakest link was a solid rubber O-ring. On January 28, 1986, the O-ring in Challenger’s booster engine failed. Hot gas knifed through the structure; the rocket exploded. Challenger and its crew, the “pride of our nation” President Reagan called them, tumbled out of the clear blue sky and shattered on the ocean sixty-five thousand feet below. If a chain must not fail, there is no point in strengthening only some of the links. Similarly, for Challenger, there could be no gain to making the booster engines stronger if the O-ring was weak. There was little point in improving guidance, or communications, or increasing the quality of crew training, if the O-ring was weak. The logic of the chain is at work in situations ranging from mountain climbing to the space shuttle to aesthetic judgment—situations in which the quality of components or subparts matters. 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 substitute two one-ton trucks to carry landfill. On the other hand, if a three-star chef is ill, no number of short-order cooks is an adequate replacement. One hundred mediocre singers are not the equal of one top-notch singer. Keeping children additional hours or weeks in broken schools—schools that can neither educate nor control behavior—does not help and probably increases resentment and distrust. Talking with real estate experts and contractors about home remodeling, I learned that in assessing a property’s potential, one should identify the limiting factors. If a house is near a noisy highway, that is a limiting factor. No matter how much marble is put in the bathrooms or how fine the cabinetry is in the kitchen, the noise will limit the house’s value. Similarly, if a room has wonderful hardwood floors and classic architecture, a less-than-excellent paint job will limit its attractiveness. As an investor, one wants to find limiting factors that can be fixed, such as paint, rather than factors that cannot be fixed, such as highway noise. If you have a special skill or insight at removing limiting factors, then you can be very successful.

  • There are portions of organizations, and even of economies, that are chain-linked. When each link is managed somewhat separately, the system can get stuck in a low-effectiveness state. The problem arises because of quality matching. That is, if you are in charge of one link of the chain, there is no point in investing resources in making your link better if other link managers are not. To make matters even more difficult, striving for higher quality in just one of the linked units may make matters worse! Higher quality in a unit requires investments in better resources and more expensive inputs, including people. Since these efforts to improve just one linked unit will not improve the overall performance of the chain-linked system, the system’s overall profit actually declines. Thus, the incentive to improve each unit is dulled.

  • The excellence achieved by a well-managed chain-link system is difficult to replicate. Consider IKEA. Formed in Sweden in 1943, the company designs ready-to-assemble furniture it sells through special IKEA-owned stores, 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 essentially substitute for a sales force. Its flat-pack furniture designs not only reduce shipping and storage costs; they also help keep the stores in stock and let the customers pull their own stock out of inventory and take their purchases home, eliminating long waits for delivery. The company designs much of the furniture it sells, contracting out manufacturing, but managing its own worldwide logistics system. IKEA’s strategy is an effective way to coordinate policies, but it is hardly secret. Won’t other companies see how it works and copy it, perhaps even improve it? The explanation for its continued excellence and the lack of any effective me-too competition is that its strategy builds on chain-link logic. IKEA’s adroit coordination of policies is a more integrated design than anyone else’s in the furniture business. Traditional furniture retailers do not carry large inventory, traditional manufacturers do not have their own stores, normal retailers do not specify their own designs or use catalogs rather than salespeople, and so on. Because IKEA’s many policies are different from the norm and because they fit together in a coherent design, IKEA’s system has a chain-link logic. That means that adopting only one of these policies does no 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, more than fifty years after IKEA pioneered its new strategy in the furniture industry, no one has really replicated it.

  • For IKEA’s set of policies to be a source of sustained competitive excellence, three conditions must hold:
    • IKEA must perform each of its core activities with outstanding efficiency and effectiveness.
    • These core activities must be sufficiently chain-linked that a rival cannot grab business away from IKEA by adopting only one of them and performing it well. That is, a traditional furniture manufacturer that adds a ready-to-assemble line is no real threat to IKEA, nor is a traditional retailer that adds a catalog.
    • The chain-linked activities should form an unusual grouping such that expertise in one does not easily carry over to expertise at the others. Thus, a traditional furniture retailer that did add a catalog would still 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 this mix of resources and competencies. 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. What is especially fascinating is that both excellence and being stuck are reflections of chain-link logic.

  • In the case of excellence, like IKEA, a series of chain-linked activities are all maintained at a high level of quality, each benefiting from the quality of the other and the whole being resistant to easy imitation.

  • It is often said that a strategy is a choice or a decision. The words “choice” and “decision” evoke an image of someone considering a list of alternatives and then selecting one of them. There is, in fact, a formal theory of decisions that specifies exactly how to make a choice by identifying alternative actions, valuing outcomes, and appraising probabilities of events. The problem with this view, and the reason it barely lightens a leader’s burden, is that you are 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—are more constructed than chosen. In these cases, doing strategy is more like designing a high-performance aircraft than deciding which forklift truck to buy or how large to build a new factory. When someone says “Managers are decision makers,” they are not talking about master strategists, for a master strategist is a designer.

  • Business and corporate strategy deal with large-scale design-type problems. The greater the challenge, or the higher the performance sought, the more interactions have to be considered. Think, for instance, of what it takes to give a BMW 3 Series car that “driving machine” feel. The chassis, steering, suspension, engine, and hydraulic and electrical controls all have to be tuned to one another. You can make a car out of high-quality off-the-shelf parts, but it won’t be a “driving machine.” In a case like this there is a sharp gain to careful coordination of the parts into a whole. Form an image in your mind of the BMW’s driver; see her taking the curves on the winding Angeles Crest Highway. Look at her face and imagine sensing her pleasure or displeasure with the automobile. Now, begin to vary the design. Make the car bigger, quieter, a bit less responsive but more powerful, heavier. Now, lighter, quicker, more responsive. To do so, you have to change the chassis, the engine weight and torque, the suspension, the steering assembly, and more. It will sway less and hug the road; the steering wheel will provide more tactile feedback. Now adjust the chassis: make it stiffer to dampen longitudinal twist and soften the front suspension just a bit to reduce road shock. Varying forty or fifty parameters, you will eventually find a sweet spot, where everything works together. She will smile and like her car. But there is more. Her driving pleasure depends upon the price paid, so we begin to include cost in our design. We concentrate on her smile per dollar. Many more interactions must be considered to find the sweet spot that gives the largest smile per dollar. You cannot search the entire space of possibilities; it is too complex. But you can probably, with effort, produce a good configuration. To get more sophisticated, you should also include the pleasure the driver takes in buying a premium brand, backed up by image advertising and swank dealers. You should also consider her buying experience and the car’s expected reliability and resale value. More design elements to adjust, more interactions to consider. And then, of course, you should consider other drivers with other tastes and incomes, a huge step upward in complexity and interaction. That difficult exercise was design. But in seeking the best smile per dollar, we took a monopoly view. Yes, we went beyond product to include manufacturing and distribution in the design, but our strategy was tuned to please the customer, not to deal with competition. To deal with competition, expand your vision again to include other automobile companies. Now you are looking for a competitive sweet spot. You have to adjust the design—the strategy—to put more smile per dollar on a driver’s face than she can get from competing products. 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—more interactions—to worry about. The new interactions are the offerings and strategies of rivals. Very quickly, you are going to focus on what you, or your company, can do more effectively than others. It will normally turn out that competition makes you focus on a much smaller subset of car models, manufacturing setups, and customers. I am describing a strategy as a design rather than as a plan or as a choice because I want to emphasize the issue of mutual adjustment. In design problems, where various elements must be arranged, adjusted, and coordinated, there can be sharply peaked gains to getting combinations right and sharp costs to getting them wrong. A good strategy coordinates policies across activities to focus the competitive punch.

  • 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.

  • A design-type strategy is an adroit configuration of resources and actions that yields an advantage in a challenging situation. Given a set bundle of resources, the greater the competitive challenge, the greater the need for the clever, tight integration of resources and actions. Given a set level of challenge, higher-quality resources lessen the need for the tight integration of resources and actions. These principles mean that resources and tight coordination are partial substitutes for each other. If the organization has few resources, the challenge can be met only by clever, tight integration. On the other hand, if more resources are available, then less tight integration may be needed. Put differently, the greater the challenge, the greater the need for a good, coherent, design-type strategy.

  • 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 integration in a design for a machine or a business. A more tightly integrated design is harder to create, narrower in focus, more fragile in use, and less flexible in responding to change. A Formula 1 racing car, for example, is a tightly integrated design and is faster around the track than a Subaru Forester, but the less tightly integrated Forester is useful for a much wider range of purposes. Nevertheless, when the competitive challenge is very high, it may be necessary to accept these costs and design a tightly integrated response. With less challenge, it is normally better to have a bit less specialization and integration so that a broader market can be addressed.

  • Companies buy pickup trucks, office equipment, vertical milling machines, and chemical processing equipment, and they hire the services of warehouses, masses of high school and college graduates, lawyers, and accountants. None of these inputs are normally strategic resources. These kinds of assets and services cannot, in general, confer a competitive advantage, because competitors have access to virtually identical assets and services on the same terms. A strategic resource is a kind of property that is fairly long lasting that has been constructed, developed over time, designed, or discovered by a company and that competitors cannot duplicate without suffering a net economic loss. A high-quality strategic resource yielding a powerful competitive advantage makes for great strategic simplicity. Consider Xerox’s patents on plain paper copying. By the mid-1950s these patents were rock solid, and it became clear that buyers would be willing to pay three thousand dollars or more for a Xerox machine—a device that cost about seven hundred dollars to manufacture. Given this large and protected competitive advantage, Xerox did the obvious—it made and sold Xerox machines. Xerox built factories, produced Xerox plain-paper photocopiers, and built 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 challenge was low. It did not need much in the way of a design-type strategy because its resource position—its patent—insulated it from competition and because the product’s value to buyers was so much greater than the cost of making one.

  • Resources are to coordinated activity as capital is to labor. It takes a great deal of labor to build a dam, but the dam’s services may then be available, for a time, without further labor. In the same way, Xerox’s powerful resource position—its knowledge and patents regarding plain-paper copying—was the accumulated result of years of clever, focused, coordinated, inventive activity. And, like a dam, once that well-protected resource position was achieved, it persisted for many years. As one senior Xerox manager told me in 1977, “The factory sold its machines to the sales division at a transfer price that was double its full cost of production. Then, the sales division doubled or tripled that transfer price to set a price for the customer.” Thus, a strong resource position can obviate the need for sophisticated design-type strategy. If, instead, there is only a moderate resource position—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 coordination of actions in time and across functions.

  • The peril of a potent resource position is that success then arrives without careful ongoing strategy work. Own the original patent on the plain-paper photocopier, or own the Hershey’s brand name, or the Windows operating system franchise, or the patent on Lipitor, and there will be many years during which profits will roll in almost regardless of how you arrange your business logic. Yes, there was inventive genius in the creation of these strategic resources, but profits from those resources can be sustained, for a time, without genius. Existing resources can be the lever for the creation of new resources, but they can also be an impediment to innovation. Well-led firms must, from time to time, cast aside old resources, just as they retire obsolete machinery. Yet strategic resources are embedded deeply within the human fabric of the enterprise, and most firms find this a difficult maneuver. Xerox, for example, built a world-class fast-response repair and maintenance service to take care of its installed base of copying machines. Thus, its initial resource—the patent on plain-paper copying—was used to create a new strategic resource. But the service system’s value lay in keeping the base of failure-prone leased machines running. And its complement was a profitable business in “special” Xerox-brand plain paper, which jammed the copiers less frequently. The next step should have been to build a world-class paper-handling capability. That would have opened the door to an early position in personal copiers, printers, fax machines, and so on. But it would also have reduced the immediate value of the Xerox service-system resource. Resting on its laurels, Xerox let Canon, Kodak, and IBM develop superior paper handling technology, while it struck off in the futile search for a way to enter the computer business with a resource base specialized around maintaining failure-prone mechanical devices.

  • A very powerful resource position produces profit without great effort, and it is human nature that the easy life breeds laxity. It is also human nature to associate current profit with recent actions, even though it should be evident that current plenty is the harvest of planting seasons long past. When the profits roll in, leaders will point to their every action with pride. Books will be written recommending that others immediately adopt the successful firm’s dress code, its vacation policy, its suggestion-box policies, and its method of allocating parking spaces. Of course, these connections are specious. Were there such simple, direct connections between current actions and current results, strategy would be a lot easier. It would also be a lot less interesting, for it is the disconnect between current results and current action that makes the analysis of the sources of success so hard and, ultimately, so rewarding.

  • Success leads to laxity and bloat, and these lead to decline. Few organizations avoid this tragic arc. Yet it is this fairly predictable trajectory that opens the door to strategic upstarts. To see effective design-type strategy, you must usually look away from the long-successful incumbent toward the company that effectively invades its market space. There you will find a tightly crafted and integrated set of actions and policies. Look at Canon, working around Xerox’s patents and creating a radically new business model based on reliable desktop copying, rather than centralized high-speed high-volume copiers. Look at the young Microsoft besting IBM; the young Wal-Mart besting Kmart; the young Dell taking business away from HP, Compaq, and IBM; upstart FedEx pushing aside the traditional air-freight carriers; Enterprise Rent-A-Car competing effectively with Hertz and Avis with a new business model; Nvidia coming out of nowhere to steal domination of the graphics chip market away from Intel; and Google redefining the search business and taking it away from Microsoft and Yahoo! In each case you will find the upstart wielding a tightly coordinated competitive strategy. In our longing for immortality, we ask that these strategic upstarts extend their success forever—the aging businessperson’s quixotic search for sustained competitive advantage. But the incumbent laxity and inertia that gave these upstarts their openings applies to them as well. In time, most will loosen their tight integration and begin to rely more on accumulated resources and less on clever business design. Relying on the profits accruing to accumulated resources, they will lose the discipline of tight integration, allowing independent fiefdoms to flourish and adding so many products and projects that integration becomes impossible. Faced with the natural slowing of growth over time, they will try to create an appearance of youthful vigor with bolt-on acquisitions. Then, when their resource base eventually becomes obsolete, they, too, will become prey to another generation of upstarts. It is 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’s posturing. Study how Bill Gates outsmarted the giant IBM or how Nucor became a leader in the declining steel industry and you will learn design-type strategy. Study Microsoft today and you will see a mature giant, reaping the benefits of past victories but just as tied to its installed base and a rich mix of conflicting initiatives and standards as was IBM in 1985.

  • One example of good strategy in which you can see the coordinated elements of design is the U.S. heavy-truck business. Daimler AG is the market-share leader (38 percent). It got that large by buying Ford’s troubled heavy-truck business in 1977. The next largest producer is Paccar (25 percent), followed by Volvo (20 percent), and then Navistar (16 percent). Plumb in the middle of a low-growth, mature, very competitive industry, Paccar nevertheless turns in a solid performance. Its return on equity over the past twenty years has averaged 16 percent, compared with an average return of 12 percent earned by its competitors. Even more important, Paccar’s profits have been remarkably stable in an industry plagued by strong upswings and downswings in demand. Paccar has not lost money since 1939, and its profit roll continues despite the recession of 2008–9. The driving element in Paccar’s strategy is quality, with its Kenworth and Peterbilt brands widely recognized as the highest-quality trucks made in North America. Paccar has received J. D. Power awards for its heavy trucks and for its service. The company prices accordingly, maintaining its strong market position despite premium prices. How can you sell a truck at a premium price? In theory it is simple—your trucks have to run better and last longer so that the owner’s cost to operate the truck is lower. Fleet operators look at differences of a fraction of a cent per mile in making purchase decisions, and the swing in costs is mostly fuel and wages. For example, if you buy a 2008 Kenworth T2000 sleeper for $110,000, and drive it 125,000 miles that year, you will probably pay another $115,000 each year in operating expenses for fuel, maintenance, repair, and insurance. And that is before wages and benefits. Because of this, Kenworth pioneered low-drag aerodynamic truck cabs thirty years ago as a way to cut fuel costs. It is not easy to hold this kind of quality leadership for three big reasons. First, no one will believe you have the longest-lasting trucks until they have already lasted a long time on the road. It’s a reputation that takes a while to earn and can be lost quickly. Second, designing a very high-quality piece of 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 future savings, even if the numbers are clear. People tend to be more myopic than economic theory would suggest. Paccar’s strategy—its design—is its way of dealing with these three obstacles to being a quality leader. The first element of its strategy is a subtle 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 day or more. Owner-drivers care about efficiency but also look beyond cost per mile, because the truck is their home, office, lounge, and TV room on the road. In addition, drivers prize the special sense of classic American style—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 suppliers for its main components and parts. The trucks are designed with as many parts in common as practicable. Truck fleet operators don’t care about aura very much; they do care about turnover and idle time among their drivers. Fleet managers find that by using two drivers, idle time is cut in half or more. That means one of the drivers is sleeping or resting in the sleeper compartment a good part of the time, 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-drivers do, many are pushed in some of the same directions by their drivers’ preferences. Whatever the fleet owner’s opinion, many of their drivers prefer Paccar trucks. Paccar’s strategy is based on doing something well and consistently over a long period of time. That has created difficult-to-replicate resources: its image, its network of experienced dealers, its loyal customers, and the knowledge embedded in its staff of designers and engineers. This position and these kinds of slow-build resources are simply not available to companies, mesmerized by the stock market, who want big results in twelve months. A flexible approach to manufacturing makes Paccar’s variable costs higher than competitors’ but provides stability for its designers and engineers. In addition, its higher margins create a loyal, more dedicated network of dealers. All of this works, in part, because it is not in a high-growth industry that would attract large new investments from outside. To attack it directly, a rival would have to create new brands and new designs, and, quite possibly, sign up new dealers. The high-end market isn’t big enough to warrant that kind of investment. Paccar’s design is expressed in actions that are consistent with its positioning and that are consistent over time. It does not make small trucks, 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, and engineers. Because it is not diversified, the talk and knowledge in the design studio, in manufacturing, and in the executive suite are about truckers and heavy trucks. They don’t need to hire a consulting firm to figure out their core competence or to find out who their buyers are. 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 clearest if you imagine a truck manufacturer assembled out of generic bits of various truck companies, a sort of Frankenstein’s monster truck company. With medium-priced truck designs aimed at fleet buyers, dealers aimed at picky owner-drivers, and design engineers trained to cut costs to the bone, it would not last long. Good strategy is design, and design is about fitting various pieces together so they work as a coherent whole. There is nothing magical about Paccar’s strategy. It is classic “hold the high ground” positioning. This defensive structure can probably be maintained as long as there are no significant structural changes in the industry’s economics or buyer behavior. Day-to-day competition in the industry is always important, and Paccar must introduce new features and models, strive to improve its quality and reduce its costs, and maintain its flexibility. But good strategy looks past these issues to what is fundamental. From that perspective, the threats to the company are not specific new products or competitive moves, but changes that undermine the logic of its design. If, for example, the NAFTA treaty encourages more and more shippers to use Mexican trucks rather than U.S. owner-drivers, Paccar’s position is at risk. Similarly, the new sophisticated computer selling introduced into dealerships may be necessary, but there is a concern that it undermines the importance of the dealer’s knowledge and expertise.

  • “If we are not going to automatically accept the opinions of others, how can we independently identify a company’s strategy? We do this by looking at 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 distinctive policies—what they are coordinated on accomplishing.” I go to the whiteboard and write “policy” over the two policies Martin called out—technical assistance and rapid response. Then I place a new column to the right labeled “Target.”

  • I point to the list of policy targets on the whiteboard and ask, “Given all this, what is Crown Cork & Seal’s focus?” The class has all the pieces, but I want them to tie these pieces to the fundamental economics of the industry. It is not easy to see this pattern, and I 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? Smaller customers … rush orders … speed … less production per customer … higher prices?” 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?” This last clue is enough. “Crown does short runs,” exclaims Julia, an entrepreneur. “The majors accept long runs of standard items to avoid costly changeovers. Crown does the opposite and has a focus on shorter runs.” I say, “Great,” as I draw a big circle around all of the elements on the target list—small customers, rush orders, and less shipments per customer—and label the circle “Shorter runs,” and sign the label “Julia,” recognizing her inductive insight. The phrase “Shorter runs” ties the company’s focus to the essential problem faced by producers in the industry—the very high costs of switching a can line from making one product to another, or even printing one label and then setting up to print another. “So we are finding that while Crown specialized in soft drink and aerosol cans, it also has a complex focus around shorter runs. The runs may be shorter because the customer is smaller, because the product is newer, because it is a low-volume high-value product, or because it is a rush order to cover seasonal or other unexpected demand, and so on.”

  • Crown and the majors are in the same industry but are playing by different rules. By concentrating on a carefully selected part of the market, Crown has not only specialized, it has increased its bargaining power with respect to its buyers. Thus, it captures a larger fraction of the value it creates. The majors, by contrast, have larger volumes of business but capture much lower fractions of the value they create. Thus, Crown crafted a competitive advantage in its target market. It isn’t the biggest can maker, but it makes the most money. This particular pattern—attacking a segment of the market with a business system supplying more value to that segment than the other players can—is called focus. Here, the word “focus” has two meanings. First, it denotes the coordination of policies that produces extra power through their interacting and overlapping effects. Second, it denotes the application of that power to the right target.

  • If the business is really successful, then there is usually a good strategic logic behind that success, be it hidden or not. But the truth is that many companies, especially large complex companies, don’t really have strategies. At the core, strategy is about focus, and most complex organizations don’t focus their resources. Instead, they pursue multiple goals at once, not concentrating enough resources to achieve a breakthrough in any of them.

  • Crown’s long record of superior performance under Connelly’s leadership had rested upon its carefully designed strategy that, through a coordinated set of policies, focused the company on products and buyers where the customer’s bargaining power was lessened. When Avery took over leadership of Crown, he found that the new PET bottles were making big inroads into the market for soft drink containers. Product changeover costs in plastics were much lower than in metal containers, so the basis of Crown’s traditional advantage was eroding. What to do? Avery chose to grow the corporation by acquisition with an emphasis on the PET business, attracted by the growth in that industry. The problem was that he left the company’s traditional competitive advantage behind without replacing it. Asked about a loss of focus, CFO Calle showed no concern, interpreting focus as merely a restriction on the product line: “It’s currently fashionable to focus, but we’ve always been there. We operate in a $300 billion industry and serve only the metal and plastic portion, which amounts to $150–200 billion.” He did not choose to understand the deeper meaning of focus—a concentration and coordination of action and resources that creates an advantage. Instead, he and CEO Avery were mesmerized by the prospects of expansion. The problem with diving into the growing PET industry was that growth in a commodity—such as cement or aluminum or PET containers—is an industry phenomenon, driven by an increase in overall demand. The growing demand pulls up profit, which, in turn, induces firms to invest in new capacity. But most of the profits of the growing competitors are an illusion because they are plowed back into new plant and equipment as the business grows. If high profits on these investments can be earned after growth slows, then all is well. But in a commodity industry, as soon as the growth in demand slows down, the profits vanish for firms without competitive advantages. Like some sort of economic black hole, the growing commodity industry absorbs more cash from the ordinary competitor than it ever disgorges. The proposition that growth itself creates value is so deeply entrenched in the rhetoric of business that it has become an article of almost unquestioned faith that growth is a good thing. CEO Avery’s description of his problem (“The company’s growth had slowed down in the 1980s”) and his goals (“We want to grow bigger … a worldwide foundation for continued international growth”) are little more than the repetition of the word “growth”—magical invocations of the name of the object of desire.

  • The problem with engineering growth by acquisition is that when you buy a company, especially a public company, you usually pay too much. You pay a premium over its ordinary market value—usually about 25 percent—plus fees. If you have friendly investment bankers and lenders, you can grow as fast as you like by acquisition. But unless you can buy companies for less than they are worth, or unless you are specially positioned to add more value to the target than anyone else can, no value is created by such expansion. Corporate leaders seek growth for many reasons. They may (erroneously) believe that administrative costs will fall with size. A poor, but common, reason for acquisitions is to move key executives to the periphery rather than 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 acquisitions law firms, and anyone who can claim a “finder’s fee”—can earn a king’s ransom by being “helpful” in a major deal.

  • Healthy growth is not engineered. It is the outcome of growing demand for special capabilities or of expanded or extended capabilities. It is the outcome of a firm having superior products and skills. It is the reward for successful innovation, cleverness, efficiency, and creativity. This kind of growth is not just an industry phenomenon. It normally shows up as a gain in market share that is simultaneous with a superior rate of profit.

  • No one has an advantage at everything. Teams, organizations, and even nations have advantages in certain kinds of rivalry under particular conditions. The secret to using advantage is understanding this particularity. You must press where you have advantages and side-step situations in which you do not. You must exploit your rivals’ weaknesses and avoid leading with your own.

  • The basic definition of competitive advantage is straightforward. If your business can produce at a lower cost than competitors, or if it can deliver more perceived value than 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 shoppers with good incomes who place a high value on organic and natural foods. Defining “sustainability” is trickier. For an advantage to be sustained, your competitors must not be able to duplicate it. Or, more precisely, they must not be able to duplicate the resources underlying it. For that you must possess what I term an “isolating mechanism,” such as a patent giving its holder the legally enforceable right to monopolize the use of a technology for a time. More complex forms of isolating mechanisms include reputations, commercial and social relationships, network effects, dramatic economies of scale, and tacit knowledge and skill gained through experience.

  • Apple’s iPhone business is protected by the Apple and iPhone brand names, by the company’s reputation, by the complementary iTunes service, and by the network effects of its customer group, especially with respect to iPhone applications. Each of these resources has been crafted by Apple executives and put in place as part of a program for building a sustained competitive advantage. These resources are scarce in that competitors find it difficult, if not impossible, to create comparable resources at a reasonable cost. Claims in advertising or sales pitches that a particular IT system or product or training program will provide a competitive advantage are misusing the term since an “advantage” on sale to all comers is a contradiction in terms.

  • To see an example of a major competitive advantage that is, 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 dominant firm in it. More specifically, eBay’s competitive advantage lies in its unrivaled ability to offer the least expensive, most effective solution to just about anyone who wishes to buy or sell a personal item online. Its broad user 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 ending in December 2009, the company had an operating cash flow of $2.9 billion, an after-tax sales margin of 26 percent, and a healthy after-tax return on assets of 13 percent. Yet, despite its competitive advantage, the company’s market value had been stagnant or declining for more than seven years. By operating, eBay definitely provides a service whose cost of provision is well below the value placed on it by customers, and does this so efficiently that others can not horn in on its core business. Nonetheless, it has not been creating new wealth for its owners. eBay’s value has been static, indicating that its competitive advantage has been static.

  • Many strategy experts have equated competitive advantage with high profitability. The example of eBay shows that this is not necessarily so. Despite all the emphasis on “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 competitive advantage. The truth is that the connection between competitive advantage and wealth is dynamic. That is, wealth increases when competitive advantage increases or when the demand for the resources underlying it increases. In particular, increasing value requires a strategy for progress on at least one of four different fronts:
    • deepening advantages,
    • broadening the extent of advantages,
    • creating higher demand for advantaged products or services, or
    • strengthening the isolating mechanisms that block easy replication and imitation by competitors.

  • Define advantage in terms of surplus—the gap between buyer value and cost. Deepening an advantage means widening this gap by either increasing value to buyers, reducing costs, or both.

  • To benefit from investments in improvement, the improvements must either be protected or embedded in a business that is sufficiently special that its methods are of little use to rivals.

  • Extending an existing competitive advantage brings it into new fields and new competitions. For example, cell phone banking is a growing phenomenon outside of the United States, especially in the less developed countries. eBay holds substantial skills in payment systems embedded in its PayPal business. If eBay could build on these to create a competitive advantage in cell phone payment systems, it would be extending a competitive advantage. Extending a competitive advantage requires looking away from products, buyers, and competitors and looking instead at the special skills and resources that underlie a competitive advantage. In other words, “Build on your strengths.”

  • Walt Disney Company has long enjoyed a substantial competitive advantage in the entertainment industry because of its ability and reputation in family-friendly fare. To appreciate the magnitude of this advantage, note that no other film company is able to pull viewers to its movies by its brand name alone. Many kids go to (or are taken to) the newest Disney film without much regard to its content. By contrast, no one goes to a movie because it is a Sony Pictures Studios product or because it was made by Paramount. Those brands have some power in financial circles and in distribution channels, but none with the consumer.

  • A brand’s value comes from guaranteeing certain characteristics of the product. But those characteristics are not easy to define. What, exactly, is a “Disney” film? How far can the brand be stretched without losing value? Mark Zoradi is president of the Walt Disney Motion Pictures Group (formerly Buena Vista Motion Pictures Group), which markets and distributes motion 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 extending it. He told me this: The most valuable thing we have is the Disney brand. Several years back, Dick Cook [then chairman of Walt Disney Studios] got us thinking hard about how to build on that strength without diluting it. Some people think a Disney movie has to be suitable for very young children. But they forget that Walt made 20,000 Leagues Under the Sea, a film that was probably much too scary for very young kids. We looked at the whole list of the most successful films in history and discovered that we would have been proud to release a surprising number under the Disney name—films like E.T., Superman, and the Indiana Jones movies. To keep the faith and still expand the brand we came up with three basic guidelines. No bad language. It’s OK for people to get angry and red in the face, but no cursing. No uncomfortable sexual situations. We want romance but we will leave making dirty movies to others. No gratuitous violence. We are all in favor of swashbuckling adventure but there will be no beheadings or spurting blood. It is this broader view that let us release Pirates of the Caribbean, National Treasure, and Prince Narnia under the Disney brand. Mark Zoradi’s three guidelines are intended to help the company extend the Disney brand into the increasingly successful action-adventure genre without damaging the brand’s value in its more traditional sector.

  • A competitive advantage becomes more valuable when the number of buyers grows and/or when the quantity demanded by each buyer increases. Technically, it is the scarce resources underlying the advantage that increase 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. Note that higher demand will increase long-term profits only if a business already possesses scarce resources that create a stable competitive advantage. Because so many strategy theorists have mistakenly equated value-creating strategy with “having” a sustainable competitive advantage, they have largely ignored the process of engineering increases in demand. Engineering higher demand for the services of scarce resources is actually the most basic of business stratagems.

  • An isolating mechanism inhibits competitors from duplicating your product or the resources underlying your competitive advantage. If you can create new isolating mechanisms, or strengthen existing ones, you can increase the value of the business. This increased value will flow from lessened imitative competition and a consequent slower erosion of your resource values. The most obvious approach to strengthening isolating mechanisms is working on stronger patents, brand-name protections, and copyrights. When a new product is developed, its protection may be strengthened by stretching an 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 verdicts may clarify and strengthen certain positions.

  • A broad approach to strengthening isolating mechanisms is to have a moving target for imitators. In a static setting, rivals will sooner or later figure out how to duplicate much of your proprietary know-how and other specialized resources. However, if you can continually improve, or simply alter, your methods and products, rivals will have a much harder time with imitation. Consider, for example, Microsoft’s Windows operating system. Were this to remain stable for a long period of time, there is little doubt that clever programmers around the world could, over time, create a functionally equivalent substitute. However, by continually changing the program—even if the changes are not improvements—Microsoft makes it very costly to engineer a continuing series of functional equivalents. Windows is a moving target. Along the same lines, continuing streams of innovations in methods and products are more difficult to imitate when they are, themselves, based on streams of proprietary knowledge. For example, a company that innovates by using scientific knowledge will have, in general, weaker isolating mechanisms than one that combines science with information fed back from lead customers or proprietary information gleaned from its own internal operations.

  • Much of academic strategy theory concerns more and more intricate explanations for why certain types of economic high ground are valuable. But such discussions sidestep an even more important question: how do you attain such an advantaged position in the first place? The problem is that, as valuable as such positions are, the costs of capturing them are even higher. And an easy-to-capture position will fall just as easily to the next attacker. One way to find fresh undefended high ground is by creating it yourself through pure innovation. Dramatic technical inventions, such as Gore-Tex, or business model innovations, such as FedEx’s overnight delivery system, create new high ground that may last for years before competitors appear at the ramparts. The other way to grab the high ground—the way that is my focus here—is to exploit a wave of change. Such waves of change are largely exogenous—they are mostly beyond the control of any one organization. No one person or organization creates these changes. They are the net result of a myriad of shifts and advances in technology, cost, competition, politics, and buyer perceptions. Important waves of change are like an earthquake, creating new high ground and leveling what had been high ground. Such changes can upset the existing structures of competitive positions, erasing old advantages and enabling new ones. They can unleash forces that may strengthen or radically weaken existing leaders. They can enable wholly new strategies. An exogenous wave of change is like the wind in a racing boat’s sails. It provides raw, sometimes turbulent, power. A leader’s job is to provide the insight, skill, and inventiveness that can harness that power to a purpose. You exploit a wave of change by understanding the likely evolution of the landscape and then channeling resources and innovation toward positions that will become high ground—become valuable and defensible—as the dynamics play out.

  • 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 increasing and that we live in an age of continual revolution. Stability, one is told, is an outmoded concept, the relic of a bygone era. None of this is true. Most industries, most of the time, are fairly stable. Of course, there is always change, but believing that today’s changes are huge, dwarfing those in the past, reflects an ignorance of history. For example, compare the changes during your life to those that occurred during the fifty years between 1875 and 1925. During those fifty years, electricity first lit the night and revolutionized factories and homes. In 1880, the trip from Boston to Cambridge and back was a full day’s journey on horseback. Only five years later, the same trip was a twenty-minute ride on an electric streetcar; with the streetcar came commuting and commuter suburbs. Instead of relying on a single giant steam engine or water wheel to power a factory, producers switched to electric motors to bring power into every nook and cranny. The sewing machine put decent clothing within everyone’s reach. 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 American life. The airplane was invented and commercialized. Modern paved highways were built and agriculture was mechanized. IBM’s first automatic 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, General Electric, Ford, and Hunt’s, date from this era. Most of the foundations of what we now see as the “modern world” were put in place, and great still-standing industrial empires were established. All of this took place in the fifty years between 1875 and 1925.

  • Now, look at another, more modern, period of fifty years. Since I was born in 1942, television has reshaped American culture, jet air travel has opened the world to ordinary people, the falling costs of long-distance transport have generated a rising tide of global trade, retail stores the size of football fields 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 momentous changes that occurred from 1875 to 1925. Historical perspective helps you make judgments about importance and significance. After a wave of change has passed, it is easy to mark its effects, but by then it is too late to take advantage of its surge or to escape its scour. Therefore, seek to perceive and deal with a wave of change in its early stages of development. The challenge is not forecasting but understanding the past and present. Out of the myriad shifts and adjustments that occur each year, some are clues to the presence of a substantial wave of change and, once assembled into a pattern, point to the fundamental forces at work. The evidence lies in plain sight, waiting for you to read its deeper meanings.

  • When change occurs, most people focus on the main effects—the spurts in growth of new types of products and the falling demand for others. You must dig beneath this surface reality to understand the forces underlying the main effect and develop a point of view about the second-order and derivative changes that have been set into motion. For example, when television appeared in the 1950s it was clear that everyone would eventually have one and that “free” TV entertainment would provide strong competition to motion 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 steady stream of B-grade movies and did not easily adapt. By the early 1960s, movie attendance was shrinking rapidly. What revived Hollywood film was a shift to independent production, with studios acting as financiers and distributors. Independent producers, freed from the nepotism and routines of the traditional studio, could focus on assembling a handpicked team to make a film that might be good enough to pull an audience off of their family-room sofas. Thus, a second-order effect of television was the rise of independent film production.

  • The work of discerning whether there are important changes afoot involves getting into the gritty details. To make good bets on how a wave of change will play out you must acquire enough expertise to question the experts. As changes begin to occur, the air will be full of comments about what is happening, but you must be able to dig beneath that surface and discover the fundamental forces at work. Leaders who stay “above the details” may do well in stable times, but riding a wave of change requires an intimate feel for its origins and dynamics. For many years, telecommunications had been one of the most stable industries. But in 1996, when Jean-Bernard Lévy and I were discussing Cisco 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 software as a source of competitive advantage and the deconstruction of the traditional computer industry.

  • Good hardware and software engineers are both expensive. The big difference lies in the cost of prototyping, upgrading, and, especially, the cost of fixing a mistake. Design always involves a certain amount of trial and error, and hardware trials and errors are much more costly. If a hardware design doesn’t work correctly, it can mean months of expensive redesign. If software doesn’t work, a software engineer fixes the problem by typing new instructions into a file, recompiling, and trying again in a few minutes or a few days. And software can be quickly fixed and upgraded even after the product has shipped. Thus, software’s advantage comes from the rapidity of the software development cycle—the process of moving from concept to prototype and the process of finding and correcting errors. If engineers never made mistakes, the costs of achieving a complex design in hardware and software might be comparable. But given that they do make mistakes, software became the much-preferred medium (unless the cutting-edge speed of pure hardware was required).

  • Driving or skiing in the fog is unnerving without any source of orientation. When a single recognizable object is visible in the mist, it provides a sudden and comforting point of reference—a guidepost. To aid my own vision into the fog of change I use a number of mental guideposts. Each guidepost is an observation or way of thinking that seems to warrant attention. The first guidepost demarks an industry transition induced by escalating fixed costs. The second calls out a transition created by deregulation. The third highlights predictable biases in forecasting. A fourth marks the need to properly assess incumbent response to change. And the fifth guidepost is the concept of an attractor state.

  • The simplest form of transition is triggered by substantial increases in fixed costs, especially product development costs. This increase may force the industry to consolidate because only the largest competitors can cover these fixed charges. For example, in the photographic film industry, the movement from black-and-white to color film in the 1960s strengthened the industry leaders. One insightful analysis of this wave of change points is that in the previously mature black-and-white photo film industry, there was little incentive for competitors to invest heavily in R & D because film quality already exceeded the needs of most buyers. But there were large returns to improvements in quality and the ease of processing color film. As the costs of color-film R & D escalated, many firms were forced out of the market, including Ilford in the United Kingdom and Ansco in the United States. That wave of change left behind a consolidated industry of fewer but larger firms, dominated by Kodak and Fuji. A similar dynamic was IBM’s rise to dominance in computing in the late 1960s, driven by the surging costs of developing computers and operating systems. Still another was the transition from piston to more sophisticated jet aircraft engines, cutting the field of players down to three: GE, Pratt & Whitney, and Rolls-Royce.

  • Many major transitions are triggered by major changes in government policy, especially deregulation. In the past thirty years, the federal government has dramatically changed the rules it imposes on the aviation, finance, banking, cable television, trucking, and telecommunications industries. In each case, the competitive terrain shifted dramatically. Some general observations can be made about this kind of transition. First, regulated prices are almost always arranged to subsidize some buyers at the expense of others. Regulated airline prices helped rural travelers at the expense of transcontinental travelers. Telephone pricing similarly subsidized rural and suburban customers at the expense of urban and business customers. Savings and loan depositors and mortgage customers were subsidized at the expense of ordinary bank depositors. When price competition took hold, these subsidies diminished fairly quickly, but the newly deregulated players chased 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 regulated companies do not know their own costs—they will have developed complex systems to justify their costs and prices, systems that hide their real costs even from themselves. It takes years for a formerly regulated company, or a former monopolist, to wring excess staff expense and other costs out of its system and to stop its accountants from making arbitrary allocations of overhead expenses to activities and products. In the meantime, these mental and accounting biases mean that such companies can be expected to wind down some product lines that are actually profitable and continue to invest in some products and activities that offer no real returns.

  • In seeing what is happening during a change it is helpful to understand that 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. Such a prediction may be valid for a frequently purchased product, but it can be far off for a durable good. For durable products—such as flat-screen televisions, fax machines, and power mowers—there is an initial rapid expansion of sales when the product is first offered, but after a period of time everyone who is interested has acquired one, and sales can suffer a sharp drop. After that, sales track population growth and replacement demand. Predicting the existence of such peaks is not difficult, although the timing cannot be pinned down until the growth rate begins to slow. The logic of the situation is counterintuitive to many people—the faster the uptake of a durable product, the sooner the market will be saturated. Many managers find these kinds of forecasts uncomfortable, even disturbing. As a client once told me, “Professor, if you can’t get that bump out of the forecast, I can find a consultant who will.” Another bias is that, faced with a wave of change, the standard forecast will be for a “battle of the titans.” This prediction, that the market leaders will duke it out for supremacy, undercutting the middle-sized and smaller firms, is sometimes correct but tends to be applied to almost all situations. For example, the “convergence” of computing and telecommunications had been predicted for many years. One of the most influential forecasts in this regard was NEC chairman Koji Kobayashi’s 1977 vision of “C&C” (computers and communications). He felt that IBM’s acquisition of a communications switch maker and AT&T’s acquisition of a computer maker illustrated the path forward. He imagined telephone systems with computing backup—telephones that would translate spoken sentences from one language 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 sought to build ever faster and more compact supercomputers. The U.S. government deregulated AT&T, in part to prepare for its anticipated battle with IBM. The problem NEC, AT&T, IBM, and other major incumbents all encountered was that convergence didn’t happen the way it was “supposed” to happen. Like two sumo wrestlers, AT&T and IBM advanced to the center 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 common fate was not the kind of convergence that had been envisioned. Along the same lines, in 1998 many pundits were predicting the emergence 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 turned out that there is no more reason for one company to own networks all over the world than there is for UPS to own all the roads on which its trucks 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 showing the largest rates of stock price appreciation. Or, more simply, they predict that the future winners will be, or will look like, the current apparent winners.
    • As aviation was deregulated, consultants advised airlines to copy Delta’s Atlanta-based hub-and-spokes strategy. But, unfortunately for the copycats, Delta’s profits had come from subsidized prices on the short-haul routes to rural towns it served from Atlanta—subsidies that were disappearing with deregulation.
    • While WorldCom’s stock price was flying high, consultants urged clients to emulate the company and get into the game of putting fiber-optic rings around cities (twenty-one around Denver!). “At 10 percent of the volume, WorldCom is already beating AT&T on per unit network costs” one report claimed. That advice had to be withdrawn when sleepy telephone companies awoke and began to cut prices. WorldCom then crashed and burned.
    • In 1999, the Web start-up advice was to create a “portal” such as Yahoo! or AOL—a website that acted as a guide to the Internet and provided a protected “playground” of specialized Web pages that users were herded toward. But although these companies were the stars of the moment, their initial strategies of capturing and channeling Web traffic were soon made obsolete by the sheer scale of the expanding Internet.

  • Uderstanding the structure of incumbent responses to a wave of change is important. In general, we expect incumbent firms to resist a transition that threatens to undermine the complex skills and valuable positions they have accumulated over time.

  • In thinking about change I have found it very helpful to use the concept of an attractor state. An industry attractor state describes how the industry “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. Having a clear point of view about an industry’s attractor state helps one ride the wave of change with more grace. During the 1995–2000 period, when the telecommunications industry was in turmoil, Cisco System’s strategic vision of “IP everywhere” was actually a description of an attractor state. In this possible future, all data would move as 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-added services,” terms that actually meant that carriers would provide special protocols, hardware, and software to support services such as video conferencing. By contrast, in the “IP everywhere” attractor state, the “intelligence” in the network would be supplied by the devices plugged into its endpoints—the network itself would be a standardized data pipeline. An attractor state provides a sense of direction for the future evolution of an industry. There is no guarantee that this state will come to be, but it does represent a gravitylike pull. The critical distinction between an attractor state and many corporate “visions” is that the attractor state is based on overall efficiency rather than a single company’s desire to capture most of the pie. The “IP everywhere” vision was an attractor state because it was more efficient and eliminated the margins and inefficiencies attached to a mishmash of proprietary standards. 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-face evidence on buyer perceptions and behavior. For example, the idea that songs and videos were simply data was, for most people, an intellectual fine point until Napster. Then, suddenly, millions became quickly aware that a three-minute song was a 2.5 megabyte file that could be copied, moved, and even e-mailed at will. As an example of an impediment, consider the problems of the electric power industry. Given the limited carrying capacity of the atmosphere for burned carbon compounds, the obvious attractor state for the power industry is nuclear power. The simplest path would be to replace coal- and oil-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 convoluted and highly uncertain licensing process—at each stage, 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.

  • 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 access to information, there is simply no good reason to continue to bundle local, national, and world news together and add weather, sports, comics, puzzles, opinion, and personal advice to the mix. I believe that as we move toward this attractor state, general-purpose daily wide-circulation newspapers will fade away. Local news and more specialized news media will continue to exist and even flourish. The strategic challenge for the New York Times and the Chicago Tribune is not “moving online” or “more advertising,” but unbundling their activities. 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 pretension than the current New York Times. It is likely that the appropriate vehicle for in-depth news analysis and investigative journalism would be a weekly magazine, ultimately delivered to a digital reader (and available free 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, partnerships with capital-city newspapers and independent journalists around the world will help (a strategy that would use the New York Times’ brand as a bargaining tool). Similar online opportunities will exist for coverage of business, politics, the arts, and science. In moving to an online model, a large traditional newspaper will need to place much more emphasis on aggregating content from a variety of sources 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 based on user demographics and revealed interests, the more a media site can charge for its placement.

  • Even with its engines on hard reverse, a supertanker can take one mile to come to a stop. This property of mass—resistance to a change in motion—is inertia. In business, inertia is an organization’s unwillingness or inability to adapt to changing circumstances. Even with change programs running at full throttle, it can take many years to alter a large company’s basic functioning. Were organizational inertia the whole story, a well-adapted corporation would remain healthy and efficient as long as the outside world remained unchanged. But, another force, entropy, is also at work. In science, entropy measures a physical system’s degree of disorder, and the second law of thermodynamics states that entropy always increases in an isolated physical system. Similarly, weakly managed organizations tend to become less organized and focused. Entropy makes it necessary for leaders to constantly work on maintaining an organization’s purpose, form, and methods even if there are no changes in strategy or competition.
  • Inertia and entropy have several important implications for strategy:
    • 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, abandon its focus on retail stores. Despite having a large early lead in mobile phone operating systems, Microsoft’s slowness in improving this software provided a huge opening for competitors, an opening through which Apple and Google quickly moved. Understanding the 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, but instead the effects of entropy and inertia. In such a situation, organizational renewal becomes a priority. Transforming a complex organization is an intensely strategic challenge. Leaders must diagnose the causes and effects of entropy and inertia, create a sensible guiding policy for effecting change, and design a set of coherent actions designed to alter routines, culture, and the structure of power and influence.

  • Organizational inertia generally falls into one of three categories: the inertia of routine, cultural inertia, and inertia by proxy.

  • Inertia due to obsolete or inappropriate routines can be fixed. The barriers are the perceptions of top management. If senior leaders become convinced that new routines are essential, change can be quick. The standard instruments are hiring managers from firms using better methods, acquiring a firm with superior methods, using consultants, or simply redesigning the firm’s routines. In any of these cases, it will probably be necessary to replace people who have invested many years developing and using the obsolete methods as well as to reorganize business units around new patterns of information flow.

  • The strategy work I did at AT&T in 1984–85 was a waste. The hard-won lesson was that a good product-market strategy is useless if important competencies, assumed present, are absent and their development is blocked by long-established culture. The seemingly clever objectives I helped craft were infeasible. It would be at least a decade before AT&T slimmed down and gained enough engineering agility to support work on competitive strategy.

  • The first step in breaking organizational culture inertia is simplification. This helps to eliminate the complex routines, processes, and hidden bargains among units that mask waste and inefficiency. Strip out excess layers of administration and halt nonessential operations—sell them off, close them down, spin them off, or outsource the services. Coordinating committees and a myriad of complex initiatives need to be disbanded. The simpler structure will begin to illuminate obsolete units, inefficiency, and simple bad behavior that was hidden from sight by complex overlays of administration and self-interest. After the first round of simplification, it may be necessary to fragment the operating units. This will be the case when units do not need to work in close coordination—when they are basically separable. Such fragmentation breaks political coalitions, cuts the comfort of cross-subsidies, and exposes a larger number of smaller units to leadership’s scrutiny of their operations and performance. After this round of fragmentation, and more simplification, it is necessary to perform a triage. Some units will be closed, some will be repaired, and some will form the nuclei of a new structure. The triage must be based on both performance and culture—you cannot afford to have a high-performing unit with a terrible culture infect the others. The “repair” third of the triaged units must then be put through individual transformation and renewal maneuvers. Changing a unit’s culture means changing its members’ work norms and work-related values. These norms are established, held, and enforced daily by small social groups that take their cue from the group’s high-status member—the alpha. In general, to change the group’s norms, the alpha member must be replaced by someone who expresses different norms and values. All this is speeded along if a challenging goal is set. The purpose of the challenge is not performance per se, but building new work habits and routines within the unit. Once the bulk of operating units are working well, it may then be time to install a new overlay of coordinating mechanisms, reversing some of the fragmentation that was used to break inertia.

  • A lack of response is not always an indication of sticky routines or a frozen culture. A business may choose to not respond to change or attack because responding would undermine still-valuable streams of profit. 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-new freedom to create money market customer accounts, how did banks respond? Smaller and newer banks seeking retail growth were happy to offer 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, they would have had to offer higher-interest accounts or disappear. But their customers were not this agile. I was a consultant to the Philadelphia Savings Fund Society (PSFS) at the time and asked about its rate structure on deposits. A vice president tried to find the brochure describing the higher-interest money market accounts and then gave up. He said, “Our average depositor is a retired person and not that sophisticated. Those depositor funds make up the last giant pool of 5 percent money left on the planet!” What he meant was that he could loan out his depositors’ money and earn 12 percent or more, while paying only 5 percent to the depositors. Sure, some depositors would depart, but most would not and the profits on their inertia were enormous. The important implication for competitors was that, at that moment, a rival could poach customers away from PSFS without triggering a competitive response.

  • Inertia by proxy disappears when the organization decides that adapting to changed circumstances is more important than hanging on to old profit streams. This can happen quite suddenly, as it did in telecommunications after 1999. Attackers who have taken business away from an apparently sleepy firm may find themselves suddenly without any profits. This effect may be magnified because the customers who switched away from the inert incumbent are, by self-selection, the most sensitive to a better offer. On the other hand, if the attacker has been successful in building bonds of cost and loyalty with newly acquired customers, then the incumbent’s return to a competitive posture may fail to gain back its lost buyers.

  • It is not hard to see entropy at work. With the passage of time, great works of art blur and crumble, the original intent fading unless skillful restorers do their work. Drive down a suburban street and it is easy to spot the untended home. Weeds grow in the garden, paint peels from a door. Similarly, one can 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 shipping schedules are too long, pleasing only the factory. Profits are taken home as bonuses to executives whose only accomplishment is outdoing the executive next door in internal competition over the bounty of luck and history. Entropy is a great boon to management and strategy consultants. Despite all the high-level concepts consultants advertise, the bread and butter of every consultant’s business is undoing entropy—cleaning up the debris and weeds that grow in every organizational garden.

  • Good strategy is built on functional knowledge about what works, what doesn’t, and why. Generally available functional knowledge is essential, but because it is available to all, it can rarely be decisive. The most precious functional knowledge is proprietary, available only to your organization. An organization creates pools of proprietary functional knowledge by actively exploring its chosen arena in a process called scientific empiricism. 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 language of science, a hypothesis, and its implementation is an experiment. As results appear, good leaders learn more about what does and doesn’t work and adjust their strategies accordingly.

  • Where does scientific knowledge come from? You know the process. A good scientist pushes to the edge of knowledge and then reaches beyond, forming a conjecture—a hypothesis—about how things work in that unknown territory. If the scientist avoids the edge, working with what is already well known and established, life will be comfortable, but there will be neither fame nor honor. In the same way, a good business strategy deals with the edge between the known and the unknown. Again, it is competition with others that pushes us to edges of knowledge. Only there are found the opportunities to keep ahead of rivals. There is no avoiding it. That uneasy sense of ambiguity you feel is real. It is the scent of opportunity. 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 hypothesis survives that test, the scientist has to devise a real-world test—an experiment—to see how well the hypothesis stands up. Similarly, we test a new strategic insight against well-established principles and against our accumulated knowledge about the business. If it passes those hurdles, we are faced with trying it out and seeing what happens. Given that we are working on the edge, asking for a strategy that is guaranteed to work is like 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 business and your industry that is unlike anyone else’s. A good strategy is, in the end, a hypothesis about what will work. Not a wild theory, but an educated judgment. And there isn’t anyone more educated about your businesses than the group in this room.

  • Social herding presses us to think that everything is OK (or not OK) because everyone else is saying so. The inside view presses us to ignore the lessons of other times and other places, believing that our company, our nation, our new venture, or our era is different. It is important to push back against these biases. You can do this by paying attention to real-world data that refutes the echo-chamber chanting of the crowd—and by learning the lessons taught by history and by other people in other places.