CHAPTER FIVE

Do You Know What Your Strategy Is?

CHAPTER 3 CLOSED with a question: Does your company (or the one you want to build) have a compelling and clearly articulated North Star? This refers to a company’s stated purpose, values, and priorities. The logical extension of this question is explored here: Do you know what your strategy is?

As I will explain in this chapter, in far too many companies the answer is no. Corporate executives often struggle with strategy formulation and communication. In such cases, the problem often starts with an inability to define genuine North Star corporate goals that can be translated into specific, measurable, achievable, relevant, and time-dependent objectives. This often leads to strategic inertia, undermining the ability to effectively respond to the accelerating pace of marketplace shifts.

Ask any CEO, and you’ll undoubtedly hear this: “Of course we know our strategy!” If this were the case, one should also get the same response from each of the company’s key constituencies: the board of directors, employees, business partners, customers, and investors. But the reality is, far too often, companies can’t or don’t express their strategy in terms that are clearly understood and embraced by their stakeholders. Or there is a serious disconnect between what senior executives say their business strategy and priorities are, and how employees are actually managed and incentivized.

According to research recently cited in the Harvard Business Review, only 29 percent of employees of high-performing companies with publicly stated strategies could correctly identify their company’s strategy out of six choices. As such, a majority of employees are not in a position to link their personal work initiatives and decision-making to the desired direction of the firm.¹ Think of it like this: a racing scull with rowers each choosing their own pace or direction would not win many races.

Discouragingly, this problem exists between senior executives and their boards as well. Of the 772 directors surveyed by McKinsey in 2013, a mere 34 percent agreed that the boards on which they served fully comprehended their companies’ strategies. Only 22 percent said their boards were completely aware of the ways their firms created value, and just 16 percent claimed that their boards had a strong understanding of the dynamics of their firms’ industries.²

A company’s stated strategic intent is also often misunderstood—or worse, not believed—by consumers or employees. For example, take the two companies with the lowest ranking among 230 companies surveyed in 2014 by the American Customer Satisfaction Index organization: Comcast and Time Warner Cable.³ Consumers have consistently reviled these companies for poor customer service and deliberately confusing business practices, belying corporate pronouncements to the contrary:

The way we interact with our customers on the phone, online, in their homes, is just as important to our success as any other products that we provide. Put simply, customer service should be our best product.

—BRIAN ROBERTS, CEO, COMCAST⁴

We’re telling our customers how we’ve made profound changes over the last two years to better respect their time, provide more value for what they pay us, and deliver the kind of experience anyone would expect from a leading entertainment and technology company. The many changes we’ve made are just the beginning of the new TWC service experience.

—ROB MARCUS, CEO, TIME WARNER CABLE⁵

In a similar vein, consider that nearly three-fourths of senior executives proclaim that innovation is among their top three corporate priorities according to a recent BCG survey.⁶ But in my experience, corporations often fail to translate such intent into meaningful action to make innovation a natural and ongoing component of an organization’s operations.⁷ For example, if you work for an organization ostensibly committed to innovation, are your answers to the following questions consistent with what you would expect?

•    How have you been trained and encouraged as a business innovator?

•    If you have a new idea, how easily can you get seed capital and the time to experiment?

•    Does your company have a culture that rewards new initiative and tolerates false starts?

•    Are all levels of management responsible for innovation, and do results contribute to compensation and career advancement?

•    Are innovation initiatives supported even in tough market conditions?

Negative responses to these questions are indicative of situations where a lack of strategic clarity or ineffective or disingenuous intent frustrates customers, confuses employees, and undermines long-term business performance.⁸

Sometimes, the problem isn’t simply poor communications, but the inherent confusion arising from a poorly conceived or ever-changing strategy. For example, prior to his resignation in 2015, Dick Costolo, the CEO of Twitter, struggled to define a strategy to translate the company’s outsized societal impact into meaningful business results, frustrating employees and investors alike. On his first post-IPO analyst call in early 2014, Costolo stressed that his sole focus would be on expanding the size of Twitter’s core user base to “reach every person on the planet.” Yet, just six months later, Costolo confusingly stated that “we think about everything we do in the context of [a] set of geometrically eccentric circles.”⁹

The Wall Street Journal noted that “the strategy shift reflected Mr. Costolo’s management style. Interviews with current and former Twitter employees and others close to Mr. Costolo and his company describe the former improv comedian as a reactive thinker who bounces from one idea to the next.”¹⁰

Twitter’s dearth of strategic clarity has been costly. In 2014 and 2015, Twitter’s active user growth slowed dramatically, executive turnover was rampant, and its market cap declined by 67 percent.

Management Hierarchy

To put the issue of strategic clarity in context, let’s start by defining terms. Figure 5.1 illustrates the four hierarchical elements required to formulate and execute effective business strategy. The starting point is a set of overarching goals that establish a company’s long-run intent and management priorities. We’ve already noted several examples in the North Star mission statements of Johnson & Johnson, Amazon, and Starbucks. A company’s stated goals identify the broad boundaries of business scope and the areas of business activity and performance of greatest concern to management, e.g., consumer satisfaction, employee safety and welfare, shareholder value, and sustainable business practices.

Figure 5.1   Management hierarchy

Objectives are more concrete and provide specific targets to guide an organization’s strategy in prioritizing initiatives, making tradeoffs, and measuring progress against defined metrics. To serve their intended purpose, objectives should be SMART:

SPECIFIC. Defined in precise terms that reflect strategic priorities, like customer retention or earnings.

MEASURABLE. Remember the saying, “You can’t manage what you can’t measure”? Objectives should be stated in terms of metrics that can be quantitatively tracked, like customer loyalty rates and total shareholder returns.

ACHIEVABLE. While objectives should ideally stretch and motivate the organization, they should be realistically achievable within a specified time frame.

RELEVANT. Objectives should focus the company’s energies on making progress towards achieving stated goals and supporting corporate values.

TIME DEPENDENT. Explicit deadlines should be established to signify whether or not objectives have been met within a prescribed time frame.

To illustrate these concepts, let’s say a firm has established the goals of providing innovative products and superior customer service to foster growth, employee opportunity, and shareholder value. SMART objectives to measure how well these aspirations have been met by the end of the current fiscal year could include: launching at least three new products in categories that show signs of reaching maturation in the market; increasing overall revenue by at least 15 percent while improving operating margins by 1.2 percentage points; achieving top-rated customer satisfaction as measured by a specified, nationally recognized market research organization; improving employee engagement scores by at least 5 percent as tracked by company-wide surveys; and growing earnings and total shareholder returns by at least 18 percent.

A company’s strategy describes how it plans to meet its stated objectives. Strategy is all about making choices, and a company’s strategy guides which market opportunities to pursue, which products to create, which distribution channels to exploit, and which business partnerships to form. Strategic choices to ignore certain opportunities are just as important as actionable commitments. For this reason, unrealistically broad targets like Costolo’s “reaching every person on the planet” provide little meaningful guidance on the focus and tradeoffs that must be made in the tactics required to implement a clearly articulated strategy.

Can You Reduce Your Strategy to a Sound Bite?

Taken together, the four elements depicted in figure 5.1 provide the basis for strategic clarity, where all stakeholders should clearly understand a company’s strategy with respect to the target customers it is intending to serve, the products and services it will provide (and not provide) in serving the needs of these customers, the basis of competitive advantage that will allow it to provide more value to the target market than competing alternatives, and the business and financial objectives that should be achieved over a specified time period if the strategy is successfully implemented.

It sounds pretty straightforward, doesn’t it? Most of my MBA students think so, until they put strategy formulation to a test suggested by a recent Harvard Business Review article titled “Can You Say What Your Strategy Is?”¹¹ In this provocative article, David J. Collis and Michael G. Rukstad challenge executives to summarize their business strategy, scope, and advantage in thirty-five words or less. Scope refers to the boundaries defining the business in terms of geography covered, customers targeted, and products and services to be offered. Advantage describes how management intends to create competitive advantage.

Why reduce business strategy to a sound bite? We’ve already seen that many companies struggle to articulate their strategy in simple terms that can be easily understood (and, it is hoped, embraced) by shareholders, employees, and customers. Forcing a company to describe its approach in thirty-five words or less stress tests strategic clarity. If the CEO can’t explain the company’s strategy in concise terms, how can he or she expect the marketplace to fill in the blanks? Companies routinely market their products in thirty-second spots, pop-up online ads, and one-line mobile banners. Short and clear messages are an everyday reality. Collis and Rukstad assert that the inability of most companies to effectively articulate their strategy in short form is proof that they lack strategic clarity.

In my class, after reading a detailed case study on the Colorado-based Coors Brewing Company, students are asked to describe the company’s business strategy in the 1970s in thirty-five words or less, and contrast it with Coors’s apparent strategy today. Two lessons learned emerge from this exercise. First, it is not nearly as easy as students expect to crystallize a company’s strategy. Despite being presented with all the relevant facts describing Coors’s market environment and the approach the company took to achieve considerable success in the 1970s, most students struggle to synthesize the essence of the company’s strategy in simple terms. Second, as the case study discussion unfolds, it becomes clear that even companies with a clear and winning strategy need to adapt their strategy over time. What worked well for Coors in the 1970s would not be effective or relevant today.

The text box below shows a “school solution” for Coors’s mid-1970s strategy expressed in thirty-five words, and how it addresses three key questions defining strategic scope and advantage.¹² Despite its brevity, this sound bite strategy conveys the tradeoffs the company made in formulating a strategy to differentiate itself from market leader Anheuser-Busch. As noted in table 5.1, Coors earned a reputation for superior taste (from clearly stated product advantages) despite its lower price (supported by economy of scale and lower regional distribution costs), allowing the company to outperform Anheuser-Busch in the western states on market share, revenue growth, plant utilization, and both gross and operating profit margins throughout the 1970s. Coors is an excellent example of how a clearly articulated and well-executed strategy can drive superior business results.¹³

TABLE 5.1

Comparison of the Strategies of Coors and Anheuser-Busch—1970s

Strategy Element	Coors	Anheuser-Busch
Market coverage	Western states	National
Customer focus	Sophisticated beer drinkers	Mass market
Brand message focus	Product superiority/authenticity	Lifestyle
Product differentiation	Rocky mountain waters, no pasteurization, premium ingredients	Nothing specific; asserted to be “King of Beers”
Operations	Single large-scale brewery	Distributed small-scale breweries
Price point	Lower	Higher

Strategic Clarity: Coors Brewing Company—1970s

[Serve discriminating beer drinkers in western states]¹ [with affordable, superior quality premium beer]² [from Rocky Mountain waters, natural ingredients, and a unique brewing and aging process in the highest scale, lowest cost vertically integrated brewery].³

1.  Who is Coors trying to serve?

2.  With what product?

3.  With what basis of differentiation and competitive advantage?

But market circumstances inevitably change, as success provokes competitive response. In the 1980s, the two largest U.S. beer companies, Anheuser-Busch and Miller, aggressively increased brewery capacity in Coors’s western market territory and engaged in an unprecedentedly intense advertising war that increased marketing expenditures on a per-barrel basis by an order of magnitude. Moreover, the growing popularity of light beers pioneered by Miller began to erode sales of full-bodied lagers, notably the company’s only product, Coors Banquet. In response, Coors radically altered its strategy by expanding to national distribution, adding a light beer and switching to less distinctive lifestyle advertising themes. As a result, virtually every element of Coors’s competitive advantage dissipated in the 1980s, leaving the company with weaker distribution, higher transportation costs, lower aggregate share of advertising voice, and less perceived product distinctiveness. Coors consequently experienced a significant decline in market share, profit margins, and market capitalization, reinforcing the imperative for strategic clarity and effective responses to shifts in the market and competitive environment.

To generalize the importance of achieving strategic clarity, responsive to current market needs, consider this thought exercise: What companies come to mind when you think of the best- and worst-managed companies? You might include Apple, Costco, or Nike in the first category and Sears, Yahoo, or Hewlett-Packard in the second. Now ask yourself which of these companies appear to have a clearer, more concise business strategy. If you can more clearly articulate the strategies of companies in the first category than those in the second, you’ve likely identified the starting point for explaining the differences in observed business performance.

Checklist for Effective Strategy Formulation

An effective strategy is one that creates, captures, and sustains value.

As shown in the left-most panel of figure 5.2, value is created whenever a company can create a product where a consumer’s willingness to pay (WTP) exceeds the company’s cost to serve (CTS).¹⁴ The difference between WTP and CTS defines the magnitude of value created, to be split in some fashion between the consumer and provider.

Figure 5.2   Value, competitive advantage, and consumer surplus

A company achieves competitive advantage when it can deliver products to the market with either a lower cost, a higher consumer WTP, or both, compared to competitors. In this case, the advantaged company creates more value in the marketplace, as shown by the height of the highlighted bars in figure 5.2. We already saw such an example when Coors enjoyed a higher consumer WTP along with a lower CTS than Anheuser-Busch’s competing Budweiser brand in the 1970s.

Where does price fit in? As shown in the right-hand panel of figure 5.2, companies can choose to price their products anywhere between WTP and CTS. This is a strategic decision that reflects how a company wants to divide the product value between itself and its customers. Consumers benefit from lower prices by enjoying a higher consumer surplus, the difference between what a consumer is willing to pay for a product and the actual price charged. High consumer surpluses spur sales, increasing growth and customer satisfaction.

Producer surplus is an equivalent concept from the opposite perspective—the difference between the price a company charges and its unit cost. Obviously, companies that enjoy a competitive advantage in the marketplace have more pricing flexibility when choosing how to allocate value between the company and consumers. In the beer industry example, Coors chose to price its Banquet lager beer below Budweiser, which helped it achieve higher sales, growth rates, market share and plant utilization. Despite lower pricing, Coors’s lower cost structure allowed it to achieve higher profit margins than Anheuser-Busch. Competitive advantage, while it lasts, is a wonderful thing.

External Alignment

The starting point for an effective strategy is the development of appealing, differentiated products with compelling value propositions, for which targeted consumers are willing to pay considerably more than the company’s unit costs. Unless the company is committed to be the low-cost provider for products in the markets it serves, meaningful product differentiation driving high WTP is the critical requirement to achieve competitive advantage. The challenge of course is that customer preferences, product technology, and the competitive landscape are highly dynamic, requiring continuous innovation to respond to ever-changing market circumstances.

Just look to the airline industry for an example of the challenges of achieving and sustaining competitive advantage.

For many years, JetBlue Airways competed on the basis of delivering a distinctive, premium coach class service at moderate (albeit not the lowest) fares, with perks not normally found on competing carriers: roomier leather seats, satellite TV service, premium snacks, free non-alcoholic beverages, and free baggage check. In contrast, many of JetBlue’s competitors chose to compete for coach class passengers on the basis of lowest baseline cost, stripping out basic amenities (e.g., seat room) while charging fees (often hidden) for every imaginable service: rebooking, baggage check, priority boarding, roomier seats, drinks, snacks, blankets, etc.¹⁵

JetBlue’s customer-friendly services have been recognized and appreciated by passengers, who have given the airline the highest rating for customer satisfaction among low-cost airlines for eleven consecutive years.¹⁶ But customer satisfaction doesn’t necessarily translate into a willingness to pay higher fares for all passengers, and competitive pricing pressures have constrained JetBlue’s pricing ability to offset its higher costs and self-imposed lack of revenue from ancillary fees. The net result has taken a toll on JetBlue’s financial performance relative to competing low-cost carriers; in 2014, its operating income as a percentage of revenue was roughly half that of Spirit Airlines, two-thirds of Allegiant Air, and three-fourths of Southwest.

In response, starting in 2015, JetBlue revised its pricing and product strategy to create and capture additional value, adding more seats to its aircraft, reducing baseline fares, charging additional service fees and adding new coach fare classes. The new strategy better matched JetBlue’s product offerings and prices to segmented consumer preferences. Customers who preferred and were willing to pay for superior perks (e.g. faster check-in, extra legroom, no baggage fees) could opt for a higher-priced service, while budget-conscious flyers could buy a no-frills ticket at a low fare.

The market response has been quite positive. In 2015, JetBlue’s operating income more than doubled relative to the prior year, while its stock price increased by 43 percent, the highest percentage gain in the U.S. airline industry. JetBlue’s example illustrates that companies need to continuously innovate to create meaningfully differentiated products and services that not only are recognized and appreciated by consumers but drive a higher willingness to pay.

Internal Alignment

The second requirement for an effective strategy is for a company to capture the value it creates in the marketplace by appropriately deciding where and how to compete, and aligning its capabilities—its core business processes, operations, management systems, and culture—to support its intended value proposition. Effective internal alignment positions a company to deliver differentiated products at a cost structure that allows it to capture most of the value created (table 5.2).

TABLE 5.2

Strategy Objectives

Strategy Objectives	Strategic Focus	Requisites for Success
1. Create value	Who to serve? Which products? What price? Deliver compelling consumer value proposition Create value-added Price relative to WTP	External Alignment: Develop products which meet differentiated consumer needs
2. Capture value	Where and how to compete? – Where in the market? – Where in the value chain? – Achieve competitive advantage	Internal Alignment: Develop capabilities to support strategy and intended value proposition
3. Sustain value	When to adapt? – How to erect barriers to entry? a. Patents b. Customer lock-in (e.g., ecosystem) c. Scale/experience d. High brand equity – When to adapt current strategies?	Dynamic Alignment: Revise strategy to respond to changes in market and competitive environment

For example, consider IBM, who enjoyed market dominance in the personal computer market in the 1980s. The IBM Personal Computer, introduced in 1981, achieved immediate market success—generating more revenue within three years than that of IBM’s four largest competitors combined.¹⁷ But IBM made what turned out to be a pivotal mistake: it outsourced the development of the operating system to Microsoft and the microprocessor design and fabrication to Intel.

This decision opened the door to low-cost imitators, who could now access the same core technologies as IBM and flood the market with PC clones. IBM relegated itself to compete on the basis of its relatively high-cost, nonproprietary computer design and assembly. Eventually, intense price competition eroded IBM’s operating margins to unsustainably low levels, prompting the company to divest its PC division to Lenovo in 2004. At the same time, “Wintel” providers—using Microsoft’s Windows operating system and Intel’s microprocessors—were able to capture most of the profits in the PC value chain (figure 5.3).¹⁸

Figure 5.3   PC value chain—1998

In this example, IBM did not align its internal capabilities to support sustained product superiority and capture significant value in the PC industry. In contrast, Apple has retained vertically integrated control over the design of proprietary operating systems, microprocessors, and its mobile apps platform, enabling it to design consistently superior computers and mobile devices and to capture industry-leading profit margins.

Let’s compare these two companies: while IBM struggled to maintain a 5 percent operating margin on its stalled PC business in the late 1990s, over the past five years, Apple has sustained an operating margin of over 30 percent, while growing at a compound annual growth rate of almost 40 percent.

Across all industries, successful companies ensure that their strategies are externally aligned with the needs of their targeted customers and internally aligned to nurture the capabilities required to deliver superior products and to capture value. Just look at Southwest Airlines, BMW, or Intuit.

Southwest strives to deliver frequent, friendly, reliable airline service to price-sensitive leisure and business travelers at a price others can’t profitably match. To do so, Southwest maintains standardized and simplified flight operations (e.g., one plane type, one class of service, no meals), strong labor relations (to enhance morale and foster a service-oriented culture), and highly disciplined growth (to avoid overextending in the cyclical, competitive airline industry). As a result, Southwest has enjoyed decades of extraordinary shareholder value growth, with highly satisfied customers and a loyal and engaged workforce.¹⁹

BMW offers premium-priced “ultimate driving machines” that are valued by a select segment of automotive enthusiasts. To support its strategic mission, BMW has built an organization that stresses R&D, state-of-the-art engineering, and disciplined product development processes, while nurturing a corporate culture committed to best-in-class motor vehicles. These are expensive capabilities to maintain, but BMW recognizes the imperative for external and internal alignment to serve a class of customer that is able and willing to pay for superior products. As a result, BMW has been among the top-selling global luxury automobile brands over the past decade, despite intense competition from Mercedes-Benz, Audi, Lexus, and others.²⁰

When Intuit entered the U.S. market in 1983, it was the forty-seventh company to offer software to help people track their finances, yet it quickly became a top seller by excelling in the creation of intuitive, easy-to-use products. To maintain market leadership, Intuit has invested heavily to instill design thinking throughout its organization, increased its design staff nearly sevenfold over the past six years, and acquired companies bringing innovative new functionality and approaches to its core product suite. Intuit’s commitment to “design for delight” has allowed it to increase its market share, revenues, and operating profit margins over the past five years in a category where fierce price competition and high topple rates—a measure of the change in market leadership— are more the industry norm.²¹

Companies that tightly link their internally and externally aligned strategies make it difficult for competitors to copy them. For example, it would be easy for a competing airline to temporarily slash fares to match Southwest or to provide bare-bones service at lower prices, but unless competitors can develop an equivalent operational focus, organizational culture, and management discipline, they won’t duplicate Southwest’s bundle of appealing service and low fares over an extensive route network. Similarly, automotive competitors have tried to claim for years that their products compare favorably with BMW at a far lower price. But automotive aficionados have generally continued to discern, recognize, and reward BMW’s product superiority, despite premium pricing. Intuit has also faced intense competition, including many new entrants offering “freemium” products promising consumers basic functionality at no cost. But Intuit’s continued Design for Delight emphasis has kept customers coming back, and allowed it to increase market share and profits over the past five years.

Dynamic Alignment

The pace of change in the underlying drivers of business performance keeps accelerating. Instantaneous global communications, big bang disruption, big data analytics, cloud-based software services, the Internet of Things, design thinking, Lean LaunchPad, global sourcing, crowdsourcing product reviews and funding, and other technology-driven forces are challenging companies across all industries to rethink their traditional business practices. Dynamic alignment is the third essential element of an effective strategy: the need to continuously revise a company’s bases of competitive advantage. Strategy renewal needs to be as dynamic as the market, technology, and competitive forces influencing business.

To put this issue in historical perspective, I fondly recall one of my first corporate strategy clients who retained my consulting firm to help them prepare their annually updated five-year strategic plan, which in retrospect reinforced incremental thinking and management rigidity. The process was a top-down, tightly orchestrated exercise in which each business unit was required to fill out a tortuously detailed questionnaire on market and competitive trends, investment requirements, and pro forma financial projections. Each division knew that other business units would be padding their investment requests, so the name of the game was to add a significant cushion to actual corporate funding needs.

When all submissions were complete, the corporate staff and consultants analyzed the data, allocated scarce investment capital, and set preliminary divisional financial targets for the coming five years. After a final round of heated divisional negotiations, the five-year plan was set in stone—or rather, in leather. The finalized five-year plan was printed on heavy stock paper and encased in a gold-embossed leather cover, lending gravitas to the guesstimates masquerading as reliable business forecasts and to the questionable relevance of the long-term strategic plans.

Despite the ensuing market dynamism and the widely recognized gamesmanship underscoring this strategic planning process, the resulting financial targets took on a life of their own. Executives strove to “make their numbers,” because underperformance carried financial and career penalties, while dramatic overdelivery would undoubtedly raise the bar for future years, increasing the risk of future shortfalls. Such rigid strategic planning processes put a premium on predictability and orderly execution, belying considerable marketplace uncertainties and relentless change.

It would be tempting to conclude that this anecdote represents a quaint and extreme historical example. Surely no modern enterprise would willfully disregard the ever-changing market and competitive environment, the increasingly frequent need to reallocate corporate capital to preempt disruptive industry forces, or the need to strategically respond to new market insights. Or would they?

Some sobering observations suggest that strategic inertia—the tendency for organizations to remain mired in the status quo and to resist strategic renewal outside the frame of current business operations—is still prevalent in corporate strategy processes.²²

First of all, too many companies still conflate their annual budgeting process with enlightened strategic planning, which unwittingly contributes to strategic inertia. The need for major strategic renewal doesn’t neatly fit into traditional annual budget cycles or processes. Traditional annual budgeting processes tend to perpetuate incremental adjustments to existing divisional budgets rather than effectively reallocating corporate capital to support major new strategic initiatives. Many of my EMBA and MBA students confirm that the budget planning process described above (and its attendant consequences) still largely persist in the firms they have worked for. As Rita McGrath writes in The End of Competitive Advantage “If you dropped into a boardroom discussion or an executive team meeting, chances are you’d hear a lot of strategic thinking based on ideas and frameworks designed in, and for, a different era.”²³

The consequence is that incumbent market leaders too often tend to prop up existing products long after they have begun to show signs of commoditization or worse, near-term obsolescence. Companies like Blockbuster, Sears, Kodak, Nokia, and Borders certainly were aware of disruptive technologies threatening their industries and had the resources to reposition their businesses. But each pursued a tepid strategic response, which ultimately contributed to their severe decline or liquidation.

Strategic inertia should not be confused with doing nothing. Each of these companies continued to actively plan and manage their businesses through the decline, investing in incremental product improvements, cutting costs and prices, and marketing existing products. This is a common response from leaders of declining businesses, whose first priority is often to protect their threatened organizations and business franchises, rather than reconceptualizing the basis of value creation in the marketplace.

McKinsey has analyzed the prevalence and consequences of corporate strategic inertia as measured by a tendency to invest the same level of capital in existing business units over long periods of time. The results of this analysis of business unit capital allocation for more than sixteen hundred companies over a fifteen-year period (1991–2005) were striking.²⁴

For one-third of the companies in the sample encompassing a diverse range of industries, the amount of capital allocated to business units in a given year was almost identical to the amount received in the prior year, despite widespread changes in their marketplaces.

Companies that did respond more dynamically to market threats and opportunities—the top third of McKinsey’s sample that shifted an average of 56 percent of capital across business units over the fifteen-year observation period—made on average 30 percent higher total returns to shareholders than the companies in the bottom third of the sample. Companies with more dynamic capital reallocation were also less likely to declare bankruptcy or to be acquired and showed increased CEO job tenure.

Why is there such a disconnect between the widespread recognition that marketplace forces are becoming more dynamic and corporate willingness to accelerate and broaden their strategic response?

There are several root causes of strategic inertia: short-term risk aversion, cognitive biases, corporate culture, bureaucratic constraints, and ineffective governance.

Short-Term Risk Aversion

In the previous chapter, I noted that in pursuit of maximizing shareholder value, too many companies adopt an overly short time horizon—one that favors cost-cutting and quick fixes over long-term investments in strategic repositioning for value creation. Managers are well aware that reallocating capital to new ventures is risky, as it entails operating in uncharted territories with respect to market acceptance, technology feasibility, and organizational execution. But such risks must be assessed against the almost certain decline in financial performance associated with sticking to aging products in the existing business portfolio. The greatest risk a company faces is often failing to respond to emerging market opportunities and threats.

Cognitive Biases

There are also significant cognitive biases that unwittingly reinforce strategic inertia: loss aversion and anchoring. Loss aversion refers to an individual’s behavioral tendency to seek to minimize losses rather than to maximize gains. This cognitive bias steers managers away from pursuing new ventures, which often require trading short-term losses for the promise of long-term value creation.²⁵

For example, in the McKinsey study,²⁶ the companies that reallocated higher levels of resources over time spans of less than three years delivered lower shareholder returns than their more static peers. But, over the long term, these dynamically managed companies significantly outperformed companies manifesting strategic inertia.²⁷

Anchoring refers to an individual’s tendency to over-rely—or to anchor—on one salient piece of information when making decisions. For example, a business unit general manager’s budget allocation for the previous year often serves as an anchor during strategic and budget planning deliberations, even if market circumstances suggest the need for a radical shift in investment focus.²⁸

Corporate Culture

Given the prevalence of gamesmanship underscoring corporate budget planning I described earlier in this chapter, cultural norms often dictate that executives “go to the mats” on behalf of their business unit. No business unit general manager wants to be seen to be losing funding relative to other divisions. Moreover, executive bonuses, self-esteem, and career progression prospects are often tied to short-term business performance. There is often no incentive for a business unit general manager to voluntarily play Robin Hood—cede a portion of his or her divisional budget—to help fund a promising venture in need of corporate investment capital.

Another form of short-term thinking may also be at play in this regard. If an executive expects to spend no more than a few years leading any given business unit, he or she will be motivated to maximize short-term results. If the business unit ultimately fails to position itself for long-term success, the consequences are likely to fall on an unfortunate successor.

Bureaucratic Constraints

Even if an enlightened senior executive within an enterprise seeks to radically rethink his or her business unit strategy, he or she is likely to be constrained by corporate management processes that influence the way a company allocates resources, evaluates employees, negotiates contracts, and communicates with internal and external stakeholders. After all, corporate strategists like to conduct elegant analytical reviews, HR likes to standardize performance management systems, lawyers like to write bulletproof contracts, and PR wants to control message content.

Moreover, these business processes are interdependent, creating a tightly woven management structure that cannot easily be pulled apart (e.g., legal reviews of HR procedures and PR press releases). For example, imagine a dynamic business leader attempting to create a new business unit requiring a distinctly different approach, requiring new skill sets, compensation schemes, and fast-paced marketing communications associated with social media. He or she is likely to find that in trying to end run one process, two or three others become upset, and pretty soon, the intrepid entrepreneur is taking on the entire corporate bureaucracy.

Ineffective Governance

As noted earlier, too often boards of directors lack sufficient understanding of their company’s strategic imperatives, sources of business unit value creation, or market and industry dynamics to provide adequate oversight. As such, there are insufficient checks and balances to offset the pervasive forces promoting strategic inertia in many organizations.

Strategy Flaws in Concept and Execution

This chapter opened with the question, do you know what your strategy is? Regrettably, we concluded that the answer is often no. Too many companies are hampered by ineffective strategy formulation, communication, or both. In such cases, the problem often starts with an inability to clearly articulate genuine North Star corporate goals, which can be translated into specific, measurable, achievable, relevant, and time-dependent objectives. Moreover, we stipulated that effective strategy needs to be externally, internally, and dynamically aligned with evolving marketplace needs. And finally, we concluded that a number of factors contribute to strategic inertia, undermining the ability to effectively respond to the accelerating pace of marketplace shifts. The next chapter will identify corrective actions.