Talking about strategy » strategy theory

Briefings 4: What causes what and how?

Kim Warren — Tue, 19 Oct 2010 10:00:26 +0000

When is theory powerful?

Whether they like it or not, decision makers use theory all the time, even if it is only their own private beliefs about why things happen and the likely impact of their decisions. Theory does not need to be complex – it is simply an explanation for what causes what, and how – without which there can be little confidence in the likely effect of any strategy we develop or decisions we might take.Theory is powerful when it is general (works in a wide variety of situations) useful (tells us something we can affect) and true. We should be skeptical about supposed “rules” of successful strategy that might seem to make sense, but are not in fact reliable, such as “the first firm to enter a new market will always beat firms who follow later.” This would be a general rule, and useful, but is unfortunately not true.Confirming the soundness of management theory is far from easy. Large scale controlled experiments are generally not possible or desirable and management typically resists becoming a lab rat! Nevertheless, there is a strong case for at least some experimentation—as is commonly done for new product launches – and there is an increasing use of “business intelligence” and analytics to support decision making.Business school research often seeks to confirm theories about what causes what by collecting large quantities of data and looking for statistical correlation between possible causes and effects. Unfortunately, the uncertainty and complexity of real-world causality is often so severe, and difficult to trace, that even a strong correlation offers little more than mild support for any theory. As Professor Clayton Christensen of Harvard Business School has remarked, we can often say little more than the business equivalent of “most flying things have feathers and flap their wings.” Attempts to design flying machines based on that statistically significant observation were not notably successful!We can start to deal with this problem by identifying parts of the explanation for performance where concrete causal connections can be stated confidently. To do this we need to work back through the problem and identify the key resources that affect the system. Whether the outcome of concern is financial or non-financial, or a combination of both, the process is the same. Whatever the focus, the key issue remains identifying how performance is changing through time.

Taking the example of airline Ryanair — profit results from the revenue the company receives from the fares that passengers pay, and from other items, minus its operating costs. These are split into some major categories — staff costs, the costs of operating aircraft, airport operations and routes — plus marketing and other costs. The causal relationships here are clear and unambiguous:

profits = total revenue minus operating costs
total revenue = fare revenue plus ancillary revenue
operating costs = aircraft costs plus route costs plus airport costs plus staff costs plus marketing costs plus other costs

If that causal explanation for profits is accurate for y/e March 2006, and the business has been conducting the same activity in the past, it was also accurate for every previous year. It is therefore possible to join up time charts of those items in the same way, as shown in the figure above. Each chart in this figure portrays the historic values for the item named. Although this diagram may be an unfamiliar view of a company’s income statement, it is just showing in a graphical, causal layout the same data we normally see in spreadsheet form.

What these diagrams mean…

Since the approach relies heavily on diagrams such as the one above (this is Figure 2.3 from the book), it is important to be clear about their features. The box at the lower right of the diagram gives a detailed legend for the time charts in the figure. Every item includes a specific, quantified scale on the vertical axis, and a specific time scale on the horizontal axis. The current value “today” — usually the latest time for which data is known — is highlighted as the green value, just above a vertical dashed line for the time at which it applies. The time path of historical data is shown as the solid green line. When adding forecasts, these are denoted by a dashed green line.

It is also important to be clear about what is meant by the connecting arrows in these charts. Word-and-arrow diagrams are common throughout books on management and strategy and usually imply some kind of causal relationship between the factors that are linked by arrows. Often, such implied relationships encompass a whole chain of causality, with all the ambiguity and complexity discussed above. In SMD, every such link will have the more localized and precise meaning that ‘A’ can be calculated or estimated from the values of ‘B’ and ‘C’ at each point in time.” The figure above follows this rule — it displays the relationships in the company’s income statements in a graphical, time-based form. These relationships hardly merit the term “theory”, being simply the conventions by which we determine a company’s profits, but they are nevertheless rigorous, reliable and well understood.

Remember we welcome your comments at any time.

Until next time…

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A common response to the principles described in chapter 2 is ‘but that’s obvious!’ – well yes it is, but if you don’t ask the right questions accurately, you are not likely to find the right answer. I pointed out to a consulting firm some time ago that their revenues come from the projects they do, and the fees for those projects, and that their profitability depends on pricing the staff time on each project correctly.

They had previously been exhorting their management to ‘improve staff utilisation’, but they had not appreciated that their people have no decision lever connected directly to this ratio [aside from simply firing people]. So a simple start-point was to put together a model of what a profitable project actually looked like – how many man-days by which types of staff, costing how much, and priced at what level. Their targets for growing revenue and profits therefore came down to how many clients had to be won, delivering how many projects, requiring how many staff.

Obvious, of course – but it was not laid out in existing plans.

What’s the use of strategy tools?

Kim Warren — Mon, 16 Feb 2009 10:07:32 +0000

On behalf of executives and consultants who really would like some useful approaches to strategy, I last week issued the following challenge to the Business School profs’ discussion lists – so far, just a handful of the thousands of recipients have responded, and no explanation offered as yet for the irrelevance of strategy research and teaching.

TO…

Business Policy and Strategy List [mailto:BPS-NET@AOMLISTS.PACE.EDU]
Management Education and Development Discussion [MG-ED-DV@AOMLISTS.PACE.EDU]

We had a great post in December from Richard Whittington [below], drawing attention to a series of articles on this topic, so thought we might see an avalanche of responses – maybe from younger folk in the field worried about its future [and theirs], or from more experienced figures vigorously refuting that there is a problem. So the subsequent silence is puzzling.
The evidence may be mostly anecdotal, but it seems increasingly recognised that students see little value in strategy classes, recruiters don’t value what those students learn in those classes, and executives and consultants don’t use the tools that have been so painstakingly put together. Why does no-one dare mention this ‘elephant in the room’?
If “there is nothing so useful as good theory” and our tools are not used, the conclusion seems inescapable – we have little useful theory! If we accept that there actually is a big problem here – where has it come from? I will probably get beaten up for this, but here goes with two suggestions …

Most of the tools, whether external or internal oriented, originate from efforts to explain profitability [rents], when that is of little interest to either investors or managers. It has been axiomatic to those in Finance for decades that investors value growth in free cash flows .. which does not correlate with maximising rents. Profitability needs to sufficient to either fund growth or enable funds for growth to be raised, and growing companies are likely to be less profitable than they could be if not growing. How long have we known this? – since Penrose in the 1950s! [ In some cases e.g. Amazon ‘sufficient’ profitability can even be negative for many years so if sustained superior profitability is the goal, where are the case studies exploring how UNsuccessful Amazon has been?!].

Most of the tools offer ways to find a good strategic ‘position’ for a firm vs. rivals .. but this question only arises at start-up or at major cross-roads in a company’s history [most of the great case study companies we use in class have sustained essentially the same ‘position’ for decades [IKEA, Southwest Airlines, eBay …] , or else made just one or two major changes [IBM, Nokia …].. so what does ‘strategic management’ actually do in between these once-in-a-lifetime events? If we were honest we would rename our classes, if not our whole field ‘Strategic Positioning’ instead of Strategic Management.

The consequences of having no useful tools for the continuing strong strategic management of organizations are serious. We are experiencing right now the result of incompetent strategic management of many of our major corporations, especially but not exclusively the banks of course. So – are we going to continue ignoring this elephant and keep churning out research and tools that no-one values, or really try to do something about it?

… excuse me while I go hide under the table.

Kim Warren

—

From: Business Policy and Strategy List [mailto:BPS-NET@AOMLISTS.PACE.EDU] On Behalf Of Richard Whittington
Sent: 10 December 2008 10:52
To: BPS-NET@AOMLISTS.PACE.EDU
Subject: FW: Business Policy and Strategy Management: Is there any differnce?

Dear All

This topic came up earlier this year, and Joe Bower mentioned a relevant Dialog forthcoming in the Journal of Management Inquiry. The Dialog has now been published under the heading: ‘Directions for a Troubled Discipline: Strategy Research, Teaching and Practice’, JMI, 17, 4, 265-286, 2008.

The three main papers are:

Joe Bower, ‘The Teaching of Strategy: From General Manager to Analyst, and Back Again?’

Rob Grant, ‘Why Strategy Teaching should be Theory Based’

Paula Jarzabkowski and Richard Whittington, ‘A Strategy-as-Practice Approach to Strategy Research and Education’.

Richard Whittington