Good Strategy Bad Strategy: The Difference and Why It Matters

by Richard P. Rumelt

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.

🙌🏾

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.

It’s better to be everything to a small group who become loyal advocates, than to be trivial to a large group.

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.

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 took some time, but I began to develop the idea that art could be, indeed, should be, a more serious subject than it was. Art is not just pretty objects; it is a vital part of human activity.

🙌🏾

Put simply, he invested where his resources would make a large and more visible difference. That is the power of concentration—of choosing an objective that can be decisively affected by the resources at hand. There is no way to know whether Williams’s strategy created greater good than a simpler strategy of giving away money, but it did make a bigger bang and, thereby, attracted more energy and support from employees and outside organizations.

More technically, leverage is a type of advantage that is context free, not being rooted in the particular mechanics of a business, industry, or situation.

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.

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.

🙌🏾

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.

Two masters trying to defeat each other in a chess game are, during a large part of the game, likely to be making moves that have no immediate end other than to “improve my position.” One does not win a chess game by always selecting moves that are directly aimed at trying to mate the opponent or even at trying to win a particular piece. For the most part, the aim of a move is to find positions for one’s pieces that (a) increase their mobility, that is, increase the options open to them and decrease the freedom of operation of the opponent’s pieces; and (b) impose certain relatively stable patterns on the board that induce enduring strength for oneself and enduring weakness for the opponent. If and when sufficient positional advantages have been accumulated, they generally can be cashed in with greater or less ease by tactical maneuvers (combinations) against specific targets that are no longer defensible or only at terrible cost.

To concentrate on an objective—to make it a priority—necessarily assumes that many other important things will be taken care of.

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.1 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 first logical problem in chain-link situations is to identify the bottlenecks,

The second, and greatest, problem is that incremental change may not pay off and may even make things worse. That is why systems get stuck.

In any organization there is always a managed tension between the need for decentralized autonomous action and the need for centralized direction and coordination. To produce a turnaround of a chain-link system, Marco Tinelli tipped the balance, at least for a while, strongly toward central direction and coordination.

Chain-link systems can be changed and made excellent. It takes insight into the key bottlenecks. Plus, it takes leadership and the willingness to absorb short-term losses in the quest for future gains.

As we learn from Marco Tinelli, turning around a chain-link system requires direct leadership and design. Conversely, the excellence achieved by a well-managed chain-link system is difficult to replicate.

Marco Tinelli’s success demonstrates that to unstick a stuck chain-linked system, a strong leader must possess the insight and fortitude to make the necessary investments in each link of the chain.

Strong systems thinking skills needed on this one.

There are furious debates over the best balance, in a strategy, between prior guidance and on-the-spot adaptation and improvisation, but there is always some form of prior guidance. By definition, winging it is not a strategy.

A fundamental ingredient in a strategy is a judgment or anticipation concerning the thoughts and/or behavior of others.

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.

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. The weight constraint made the whole thing a web of competing needs, and it all had to be considered together.

Nothing I had learned in engineering school at UC Berkeley prepared me for thinking about this kind of design problem. There, I had learned how to mathematically model systems and then minimize something, such as cost or least-squared error. But this work at JPL was different. I had to learn enough about all the subsystems and their possible interactions, and hold it all in my mind, in order to imagine a configuration that might be effective. This was difficult, to say the least. I didn’t know it at the time, but I was beginning to learn strategy.

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.7 Put differently, the greater the challenge, the greater the need for a good, coherent, design-type strategy.

🙌🏾

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.

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.

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.

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.

If you are serious about strategy work, you must always do your own analysis. A strategy is not necessarily what the CEO intended or what some executive says it is. Sometimes they are hiding the truth, sometimes they are misstating it, and sometimes they have taken a position as leader without really knowing the reasons for their company’s success.

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.

The basic definition of competitive advantage is straightforward. If your business can produce at a lower cost than can competitors, or if it can deliver more perceived value than can 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.

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.2 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.

Stewart Resnick, the chairman of privately held Roll International Corporation, and his wife, Lynda, are serial entrepreneurs. Not only have they established several very successful companies, they have also used their wealth to support medical research, education, and the arts. Being able to create successful strategies, not just once but over and over again, is a rare skill. And it is clear that their skills are not rooted in any one industry—they have been able to succeed in alarm services, flower delivery, collectibles, agribusiness, and bottled water.

“Things don’t happen with lightning speed in agriculture,” Stewart explains. “It takes seven to ten years for newly planted trees to mature. That gave us time to invest in planting, branding, processing, and merchandising. Then, as demand grew, we aggressively built nut-processing capacity. The scale economies in processing make it hard for smaller farmers to build their own processing facilities. And unless you can do processing, packaging, marketing, branding, and distribution, it may not pay to buy more land and plant new trees.”

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.

Deepening Advantage Start by defining 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.*

Today, this approach to information flows and business processes is sometimes called “reengineering” or “business-process transformation.” Whatever it is called, the underlying principle is that improvements come from reexamining the details of how work is done, not just from cost controls or incentives. The same issues that arise in improving work processes also arise in the improvement of products, except that observing buyers is more difficult than examining one’s own systems. Companies that excel at product development and improvement carefully study the attitudes, decisions, and feelings of buyers. They develop a special empathy for customers and anticipate problems before they occur.

Broadening the Extent of Advantage Extending an existing competitive advantage brings it into new fields and new competitions.

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.” The idea that some corporate resources can be put to good use in other products or markets is possibly the most basic in corporate strategy.6 Its truth is undeniable yet it is also the source of great mischief. Bemused by the idea that their company’s competitive strength lies in vaporous generalities such as “transportation,” “branded consumer products,” or “management,” companies may diversify into products and processes they know nothing about.

A brand’s value comes from guaranteeing certain characteristics of the product. But those characteristics are not easy to define.

🙌🏾

Creating Higher Demand 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.

Strengthening Isolating Mechanisms 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 “network effect” increases the value of a product as the number of buyers or users gets larger. It is like an economy of scale, but instead of reducing the producer’s cost, it increases the buyer’s willingness to pay. We see very strong network effects in businesses like Amazon and Facebook.

A thought experiment tests ideas for logical consistency and logical implications.