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Briefings 3: Three key questions for strategy design

Kim Warren — Tue, 05 Oct 2010 10:11:01 +0000

This is the third post in the fortnightly series of Strategy Dynamics Briefings.

There are three distinct, but related questions lying behind the issue of how businesses and other organizations perform through time… What are they?

(If you would like to receive the series from the beginning in your email inbox, please register on www.strategydynamics.com and subscribe to Briefings in “MyAccount”)

In my last post I explained that the time path of future performance is central to the concerns of investors in commercial firms.

The three distinct questions lying behind the issue of how businesses and other organizations perform through time are:

Why has our historical performance followed the time path that it has?
Where will the path of future performance take us if we carry on as we are?
How can we improve that future performance?

The first question may not be relevant in every case — for example a new venture startup has no history. However, in most cases, history is highly relevant to the likely trajectory of future performance. To illustrate the importance of these three questions look at the example of Amazon.com, mentioned last time. This story is dealt with in more detail in the book.

Amazon.com is an outstanding growth story, as the company expanded from online books sales to an increasingly wide range of other high-value/small-size consumer goods. Since its founding in 1994, the company has promised and delivered growth in its business although it took until 2002 to translate increasing sales volume and revenue into profitability.

So how do our three questions apply to Amazon.com?

Why has our historical performance followed the time-path that it has?

Sales have grown strongly as consumer uptake of online purchasing has spread and as Amazon.com has extended its product range and entered new geographic markets. Earnings have bounced back from heavy losses into positive profitability, as early expenditure generated the sales growth and gross profits to more than cover the continuing costs of serving customers’ demand.

However, the company’s development could feasibly have followed a different path, even if it ended up at the same point in 2005. Figure 1.6 in SMD, shown above, compares the company’s actual record with an alternative, fictional history. In this other world, the answers to our first question would be quite different. The company might have grown its revenues still more strongly between 1999 and 2002 than it actually did, due to an even faster penetration of online shopping by consumers or extension of its product range and services. From 2002 to 2005, sales growth could have slowed and reversed, perhaps due to saturation of the potential market, the emergence of strong competitors, or a slowdown in the company’s expansion of its offerings. The alternative income line is more worrying still, and explanations might include reduced margins due to competitive activity, poor cost control, or deliberate increases in spending in an effort to restart growth.

Where will the path of future performance take us if we carry on as we are?

This second question shows the importance of answering the first. The two alternative histories must imply very different prospects for the future, even though the 2005 endpoint is identical. If we extend the time horizon beyond 2005, a plausible future for Amazon.com is that sales continue to grow for much the same reasons they have in the past—more consumer use of online shopping and extended coverage by the company of product and geographic markets. As a result, profits continue to grow.

But the answer to “where might we be heading?” would likely be very different, had the alternative history occurred. Now we are worried that the slowdown in sales could become a serious downturn, especially if the recent history had reflected progress by powerful rivals. If this were to come about, the profit forecast could be very disappointing, with the company slipping into losses as it struggles to contain costs that it has built up to support a growing sales rate.

How can we improve that future performance?

Amazon.com’s actual history to 2005 offers encouraging prospects for sales and profit growth thereafter, so in reaality. answers to this third question focus on pushing growth just a little faster, while not risking damage to the business system that supported its performance to date. Perhaps further product and service development would drive additional growth, and this could plausibly lead to still higher profits.

The answers to this third question would have appeared very different if the company had reached 2005 by the alternative path. Instead of asking how the firm might safely push for even faster growth, it would instead be worrying about how to stop sales revenue slipping backwards, and then how to restart growth. Such a turn-round would likely be costly, so the time path of recovery might well show an even worse profit performance in the next year or two than the “do nothing” projection.

Your business history will probably be quite different from Amazon’s, but the questions will be the same. Through the course of the book and these emails I will show more examples, in different cases that I hope will demonstrate that for you.

Remember we welcome your comments at any time.

Until next time…

Briefing Number 3

I love it when the lightbulbs go on!

When I am teaching it’s great to see the reactions when people identify something that makes a real difference for them. In my executive classes in particular there have been insights related to areas that, from the outside, you would have thought would have been obvious – but the sad reality is that people are so often chasing a target that they often don’t manage to look at the overall picture.

I recall one person who ran a mid-sized security firm – the kind that provides guards for buildings of different kinds. He kept driving his head of sales to win new clients, but business was still not growing. When we looked at his numbers, it turned out that he had about 100 client, and each year added 100 new ones, but lost the same number. [Not many cases are quite so extreme!]

How had he got in this awful situation? Well a few quarters ago, HQ were pressing for more profit, so he had to cut back on the staff who did the actual security work for clients. Service quality fell, so next quarter some of his clients did not renew their contracts. Sales and profits fell, so HQ said ‘More profit please’. [Only not so politely!]

In order to sustain profit growth he set bigger sales targets – which his head of sales managed to hit. Taking on new clients meant more work, and with no more staff, service quality fell again, so next quarter still more clients cancelled their contracts. So sales and profits fell … so HQ shouted again … and so it went on, with ever-growing churn amongst his customers.

Getting out of the mess was tricky. Clearly, chasing still more new business was not working – apart from anything else, he was fast working through all the potential customers in his region! The solution was a significant, but selective cutting of still more clients. Mad eh! .. our business is in a mess, losing customers, so you tell me I should deliberately throw away some of those I’ve got? Yes – but the selection process isolated a significant number who were unprofitable, because they had demanded uneconomic prices or service levels that were too costly. Serving a smaller number of customers, even with the same number of staff actually raised profits and improved service. [We will see more about how this can happen in a later briefing - but that is some way off yet].

… from where he could start building business again, but with a little more care.

More on sustainability and strategy

Kim Warren — Tue, 10 Nov 2009 16:49:49 +0000

Two solid pieces on strategy implications from sustainability. The Business of Sustainability report from BCG reviews the impact the issue is having on companies and how it is affecting their strategic management. Most now see it as far more than just the latest fad and potentially a big factor in their future success – or failure. Sloan Mgmt Review summarises this report, 5 mini-cases on Nike, Rio Tinto, GE, Better Place and Wal-Mart, and articles on implications for competitive conditions and for talent-management.

Great piece on sustainability and business

Kim Warren — Tue, 14 Jul 2009 14:59:45 +0000

Great video with Adam Werbach, author of Strategy for Sustainability: A Business Manifesto, shares an adaptation from his book and talks with the McKinsey Quarterly about trading in green fashion for more enduring business solutions. Practial and commercial.

Business case for sustainability

Kim Warren — Tue, 12 May 2009 15:58:30 +0000

Michael Olson of Pleiades Technology Futures just pointed me to what looks some solid materials on how to make the business case for investing in sustainability from Bob Willard at Sustainability Advantage. This contrasts strongly with much of the well-meaning but mostly futile aspirations of many sustainability advocates.

Bob’s approach is extremely clear and expressed in terms that would likely grab exec attention – pointing out in particular that many substantial investments in sustainability offer a perfectly good financial return in conventional terms, even before adding the intangible value of external benefits. We can go further though – Bob’s seven-stage sustainability change process in summary goes [with much more behind it!] …

1 Wake up and decide
2 Inspire shared vision
3 Assess current realities
4 Develop strategies
5 Build the case for change
6 Mobilize commitment
7 Embed and Align

… and that alone would seem to make a case for a great deal of change and investment in many companies. The main unresolved issue, though, is exactly the same in this Sustainability domain as it is in strategy generally – when you have got through steps 1-3 you have to ‘4. Develop Strategies’ and ‘5. Build the Case for Change’.

But without a rigorous model of how the business system actually works and delivers performance [which is why many firms did not have strategies to avoid, prepare for, or deal with the current crisis], it will be tough to do steps 4 and 5 well, and if that’s not in place, steps 6 [Mobilise] and 7 [Embed] will be tough too.

All that is needed for strategy dynamics to encompass this is to extend the business model beyond the firm boundaries to incorporate those sustainability issues [a trivial example being to add fuel consumption to the Ryanair model, plus the energy and raw materials used to make its aircraft, etc]. Such extensions are easy to see in many of the sustainability-related initiatives being pursued by the likes of Walmart.

The tricky challenge comes when the sustainability initiatives are not self-evidently cost effective, but are realised – or can be made to be so - when management gets to work on the wider system. E.g. many leading UK firms are doing things that clearly have a negative conventional ROI, but generate long-term returns when the combined effects of accumulating intangible resources, plus self-reinforcing feedback, are engineered into the system.

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Sustainability and strategy

Kim Warren — Sun, 08 Mar 2009 09:51:55 +0000

Good to see a serious management journal – MIT’s Sloan Management Review – regularly featuring items on this issue. John Sterman’s ‘Sober optimist’s guide to sustainability‘ and an interview with Rebecca Henderson are both good. Rebecca uses the fact that making every shirt uses hundreds of gallons of water to point out that we are just not aware of wider consequences of what we do – and if we don’t know, we are hardly likely to act, either as consumers or firms. There are tons of basic facts like this, e.g. there are about 5 acres (2 hectares) of land area for each person on the planet, about five football pitches – rather less if we leave out barren territory, so everything we consume and all the waste we produce has to come from and return to just that small area.

For thinking about implications for strategy, I’ve just been pointed to Green to Gold by Daniel Esty and Andrew Winston, which looks at what leading companies are already doing. It’s pretty easy to extend the strategic architecture of a business to incorporate its impact on natural resources, and I will include a summary of how that works in the next edition of my textbook.

Sustainability MBA

Kim Warren — Thu, 11 Dec 2008 12:38:16 +0000

Following a couple of posts on sustainability, it’s interesting to find at least one dedicated MBA in the topic, at Presidio School of Management [who also offer shorter executive classes]. I don’t have any information on its quality, so would be interested to hear feedback on this or any other such program.

Strategy and sustainability

Kim Warren — Tue, 09 Dec 2008 09:26:47 +0000

Had a couple of interesting contacts on this last week. Seems senior executives in general certainly ‘want to do what’s right’, but face two difficulties. First, it’s not as obvious as it seems to know what the right thing is to do [think of the debates about exploiting cheap labour vs. destitution and poverty]. Secondly, it’s hard for CEOs to make the business case for doing things that seem to be just costly. We can help on both issues.

First, my friend Tom Cummings at Executive Leadership Partnership has been doing some good events with top teams specifically on global warming. He and Drew Jones of the Sustainability Institute have taken groups through the C-roads simulator [previously 'Pangaea']- a decision-maker-oriented climate simulator to support climate policy design [it doesn't need a super-computer, just a regular laptop!]. Also involved in this effort are Felicitas von Peter Director of the Forum for Active Philanthropy in Berlin and Dr. Robert W. Corell, IPCC scientist and Vice President for Programs at the Heinz Center.

Why take business teams through this? – because they, like most folk, lack an understanding of the basic but critical issues. For example, if we cut CO2 emissions, we might imagine that atmospheric CO2 levels would fall – they won’t. If your bath is about to overflow, turning the tap down [faucet for US friends] won’t stop it!. We may also think that if CO2 levels don’t rise, global warming will stop. It won’t - what’s already up there will keep trapping heat. The C-roads simulator connects these and other issues to the diverse implications for populations in different economic circumstances – developed and developing economies, and the poorest. More on related issues at the European Environment Agency, European Climate Foundation, and Tallberg Foundation. Only if management understands these and other mechanisms will they understand how their organizations’ activities are involved and see why and how to change things.

The thing that sets apart what Tom and his network are trying to do is its ultimately practical purpose – helping top teams work out what’s right to do and how to get it done fast, whilst at the same time supporting and even enhancing business performance. I have bumped into some disappointing initiatives in this area, e.g. arcane attempts to model the infinite complexity of everything, and ego-driven back-biting amongst fringe scientists and pressure groups. The danger of both is that they suck attention, effort and cash away from real efforts to fix the problems.

The second step Tom wants to pursue is helping top teams integrate sustainability considerations with organizational strategy. By coincidence, I also attended a reception with Forum for the Future, launching their report “Acting Now for a Positive 2018, preparing for radical change: the next decade of business and sustainability” [by all means download this, but please save paper and don't print it!], authored by David Bent and others, and sponsored by CapGemini‘s head of corporate social responsibility, James Robey. Capgemini’s commitment to sustainability is admirable – according to their speaker, Christine Hodgson, they decided they just had to set some targets and get started, even if the targets weren’t perfect.

The challenge for both Tom at ELP and David at FftF is to help organizations embed sustainability into their strategy, and that requires embedding a rigorous analysis of how those organizations’ business systems integrate with the external factors of concern – scarce resources, CO2 emissions, waste, and social issues. This is exactly what strategy dynamics does, so I and my friend Suresh Mistry at Strategy Dynamics Solutions are working to help in these efforts.

Socio-political issues – lead or follow?

Kim Warren — Sat, 01 Nov 2008 09:10:30 +0000

I’m sceptical of the value from surveys of executive opinion – why should I care e.g. whether X% of CEOs think that getting the talent they need is a problem? This one on attitudes to socio-political issues is interesting, but begs the same question. At least it makes the point that these big outside factors can present opportunities as well as theats. I’d go further, and be looking for ways to lead changes that would be desirable. Some really big issues will be way out of reach, of course, but plenty of firms have significant influence – see earlier post on Wal-Mart efforts on sustainability, which cannot help but have an effect on public attitudes.

And this is not just a consideration for the super-big firms. Much smaller businesses can make a significant impact on the attitudes of local consumers and local government, or on customers and others in their particular market segment.

This is an important strategic management capability that deserves more attention – especially when there is the opportunity to make the world a better place, as well as grow cash flows!

Wal-Mart = ‘Environmental Protection Agency’?

Kim Warren — Fri, 31 Oct 2008 15:24:24 +0000

Sloan Mgmt Review highlights a New York Times article on Walmart’s toughening stance on environmental sustainability. It also points out the inherent conflict in this – that W. relies on selling ‘stuff’ in vast quantities. Yet even so, their leverage over suppliers may make them a very effective ‘Environmental Protection Agency’.

This is an intrisically unsustainable activity, but the headline reminds me of some discussions with the David Bent of Forum for the Future, which is working hard to help businesses ‘make the case’ for including sustainability in their strategies and investment. FftF takes a broad view of this, based on its ‘Five Capitals’ model, which covers what it describes as Natural, Human, Social, Manufactured and Financial ‘capitals’.

To include this in an organisation’s strategic business management, the strategy dynamics approach would treat these just as any other accumulating asset-stocks, making the model considerably more usable and amenable to forming the foundation of any business case. The key structure as regards environmental sustainability is the three-stock chain from [a] natural resources, to [b] manufactured goods, to [c] waste. The chain can work in two ways.

For ‘consumables’ like oil the natural resource is depleted and moves straight to an accumulation of waste.
For ‘durables’ like metals the natural resource is converted into manufactured goods and then into waste.

The distinction is not absolute, since some items are durable for such a short time [e.g. clothing] that on the time-scale of sustainability issues they are effectively consumable. The value of the structure is the clarity it brings to the key movements in the system – as in all policy and strategy issues, it’s the flow-rates that are critical, i.e. tons per year moving forward and back between these three states.

It’s pretty easy to build on this core model of the environmental system of which a business is a part to work out how changes in strategy might make its activity more sustainability-compliant [if not totally so] and deliver investor benefits.