Good Strategy Bad Strategy: The Difference and Why It Matters

by Richard P. Rumelt

This executive’s problem was primarily organizational rather than rooted in product-market competition. Yet the kernel of strategy—a diagnosis, a guiding policy, and coherent action—applies to any complex setting. Here, as in so many situations, the required actions were not mysterious. The impediment was the hope that the pain of those actions could, somehow, be avoided. Indeed, we always hope that a brilliant insight or very clever design will allow us to accomplish several apparently conflicting objectives with a single stroke, and occasionally we are vouchsafed this kind of deliverance. Nevertheless, strategy is primarily about deciding what is truly important and focusing resources and action on that objective. It is a hard discipline because focusing on one thing slights another.

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.

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.

As a simple example, salespeople love to please customers with rush orders, and manufacturing people prefer long uninterrupted production runs. But you cannot have long production runs and handle unexpected rush orders all at the same time. It takes policies devised to benefit the whole to sort out this conflict.

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.

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.

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)

Her lunar specification wasn’t the truth—the truth was that we didn’t know. It was a strategically chosen proximate objective—one the engineers knew how to tackle, so it helped speed the project along. And it was sensible and clever at the same time. You could write a PhD thesis on the options analysis implicit in her insight that if the lunar surface wouldn’t support a straightforward lander, we had more than a design problem—the whole U.S. program of landing a man there would be in deep trouble. Writing the history of Surveyor, Oran W. Nicks said, “The engineering model of the lunar surface actually used for Surveyor design was developed after study of all the theories and information available. Fortunately, this model was prepared by engineers who were not emotionally involved in the generation of scientific theories, and the resulting landing system requirements were remarkably accurate.”4 This lunar surface specification absorbed much of the ambiguity in the situation, passing on to the designers a simpler problem. Not a problem easily solved, or to which a solution already existed, but a problem that was solvable. It would take time and effort, but we knew that we could build a machine to land on Phyllis’s moon.

Phyllis’s insight that “the engineers can’t work without a specification” applies to most organized human effort. Like the Surveyor design teams, 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 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. Herbert Goldhamer’s description of play between two chess masters vividly describes this dynamic of taking positions, creating options, and building advantage:

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?

To concentrate on an objective—to make it a priority—necessarily assumes that many other important things will be taken care of. PJ was able to concentrate on the coordination between his helicopter and the rescue vessel because he already possessed layer upon layer of competences at flying that had become routine.

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.

Without corruption, it would be impossible to get around the stifling bureaucracy, but bureaucracy is a necessary counter to nepotism and a culture of corruption.

I conducted three campaigns, one after another. In the first campaign we spent twelve months just on quality. I told the employees that everything we did for the next year would be to make our machines the best in the industry, the most reliable and the fastest. Once we had good quality machines, I focused entirely on the sales function. The salespeople had been involved in the quality campaign, and now the engineers and manufacturing people worked with sales to build skills, selling tools, and communications links back to the factory. Market results were slow in coming, but I knew we had to make these investments first to reap benefits later.

The first logical problem in chain-link situations is to identify the bottlenecks, and Marco did that—quality, sales’ technical competence, and cost. 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. Marco’s solution to this problem was to take personal responsibility for the final result and direct others’ attention to the three bottlenecks, one after another. There were no immediate returns to the first campaign, but he did not stop nor did he operate a system that heaped blame on his department managers. Instead, he congratulated them for achieving the proximate goal of the first campaign and moved on to the second. There are little or no payoffs to incremental improvements in chain-link systems, but Marco avoided this problem by shutting down the normal system of local measurement and reward, refocusing on change itself as the objective.

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.

The big improvements came from cutting two products out of the line and bringing in-house some tools and dies we had been buying from other companies. By making our own dies we increased the speed of the machines, and thus increased their value to our customers. The price of the machine did not fall, but the cost to the user did. It took a sophisticated sales-engineering team to get this point across to our customers, which was another reason for making this type of cost reduction the last step.

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.

On the other hand, when a series of chain-linked activities are of low quality, as in General Motors circa 2007, the system can be stuck, because there is little gain to improving only a fraction of the activities.

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.

It will normally turn out that competition makes you focus on a much smaller subset of car models, manufacturing setups, and customers.

Our basic constraint was weight.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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 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.

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.

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.

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.

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.*

Virtually drowning in a twenty-four-hour barrage of superficial news and commentary, the students are surprised that the real world can sometimes have an inner logic that is not secret but that nevertheless remains unremarked. “Is it always this way?” a student asks me. “If you do the work, can you find the real strategic logic of every business?” “No,” I reply, “not of every business. 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.”

Commenting on the purpose of the combination, Avery said, “We want to grow bigger and get a better use of our resources. As the global leader in the metal and plastic segments of the packaging industry … we will have a worldwide foundation for continued international growth.”2 Few executives have been so clear in stating that they want to grow in order to have a platform for further growth.

No one mentioned the awkward fact that Crown’s traditional competence had been flexibility and short runs, not cost control.

During the ten years (1980–89) before Avery become CEO at Crown, revenues grew at only 3.1 percent per year. However, it had nevertheless generated an annual average return to shareholders of 18.5 percent,

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.”5 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 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.