Good Strategy Bad Strategy: The Difference and Why It Matters

by Richard P. Rumelt

This personal skill is more important than any one so-called strategy concept, tool, matrix, or analytical framework. It is the ability to think about your own thinking, to make judgments about your own judgments.

In strategy work, knowledge is necessary but not sufficient. There are many people with deep knowledge or experience who are poor at strategy. To guide your own thinking in strategy work, you must cultivate three essential skills or habits. First, you must have a variety of tools for fighting your own myopia and for guiding your own attention. Second, you must develop the ability to question your own judgment. If your reasoning cannot withstand a vigorous attack, your strategy cannot be expected to stand in the face of real competition. Third, you must cultivate the habit of making and recording judgments so that you can improve.

The creation of new higher-quality alternatives requires that one try hard to “destroy” any existing alternatives, exposing their fault lines and internal contradictions. I call this discipline create-destroy.

Steve Jobs, cofounder of Apple, founder of NeXT, and CEO of Pixar until it was acquired by the Walt Disney Company, is the world’s best-known Silicon Valley entrepreneur. Since guiding the development of the Macintosh computer, Jobs’s basic operating principles have become the stuff of legend: (1) imagine a product that is “insanely great,” (2) assemble a small team of the very best engineers and designers in the world, (3) make the product visually stunning and easy to use, pouring innovation into the user interface, (4) tell the world how cool and trendy the product is with innovative advertising.

If you can keep your head when all about you Are losing theirs … —“IF,” RUDYARD KIPLING Good strategy grows out of an independent and careful assessment of the situation, harnessing individual insight to carefully crafted purpose. Bad strategy follows the crowd, substituting popular slogans for insights.

I began to realize that the “cost” of moving data over all of these cables was essentially zero, whether they were fat or narrow. And, with the advent of competition in a formerly monopolized industry, there was nothing keeping prices from falling to cost.

The financial and economic crisis of 2008 was the bursting of an immense credit bubble, the largest in history. In a credit bubble, lending standards become less and less stringent. Easy credit, in turn, helps drive up prices within a class of assets, usually real estate or equities. These newly risen asset values then form the collateral for further borrowing. The recent credit bubble had a large real estate component but extended to a wide variety of deals—leveraged buyouts, major mergers, industry roll-ups, certain hedge funds, and so on.

This feedback from debt to asset sales, to falling asset prices, back to more defaults and yet more asset sales, is called “debt deflation.” It was first explained by Irving Fisher in the midst of the Great Depression. Easy credit quickens the boom, and its consequences accelerate the bust.

There was what I call the smooth-sailing fallacy, where people assume that a lack of recent tremors and storms means that there is no risk. This fallacy was institutionalized by the financial industry’s doctrine of measuring risk by analyzing past vibrations in prices. A system with a critical design flaw—such as the Hindenburg, the New Orleans levees, or the building of a mountain of securities on the premise that home prices never decline—does not necessarily display the flaw until it collapses. The collapse is virtually certain, but it is not signaled by a history of shakiness or vibration. Importantly, the collapse is not due to totally unforeseeable or almost impossible events—things the financial community tends to call “black swans”6 or “tail-risks.” Given the design flaws in the system, a collapse was inevitable.

There is social herding. When we don’t know about something, it may be sensible to look at the behavior of others, assuming that at least some of them know things that we do not. But if everyone else is doing the same, then this process of mutual calibration can result in all the members of a group undertaking uninformed actions or believing that the “other guy” is paying attention to fundamentals.

America’s first depression, in 1819, was a direct result of the government selling large tracts of public land on easy credit. These sales were especially concentrated in Tennessee, Mississippi, and Alabama. Attracted by high prices for crops, especially cotton, settlers borrowed heavily from highly leveraged state banks to purchase land and supplies. The consequent massive increase in production, coupled with the gradual recovery of European agriculture from the devastation of the Napoleonic wars, triggered a collapse in prices in 1819. In 1818, cotton was 31 cents a pound; in 1819 it was half that, and by 1831 it had fallen to 8 cents a pound. Land prices followed suit and massive defaults ensued. The crisis was exacerbated by the Second Bank of the United States’ policy of calling in loans and demanding payment in specie.* The crisis spread to the cities and, in Philadelphia, real estate prices fell by 75 percent. Thousands languished in debtors prisons.

Social herding presses us to think that everything is OK (or not OK) because everyone else is saying so. The inside view presses us to ignore the lessons of other times and other places, believing that our company, our nation, our new venture, or our era is different. It is important to push back against these biases. You can do this by paying attention to real-world data that refutes the echo-chamber chanting of the crowd—and by learning the lessons taught by history and by other people in other places.