Good Strategy/Bad Strategy: The difference and why it matters

by Richard P. Rumelt

pivot point magnifies the effect of effort. It is a natural or created imbalance in a situation, a place where a relatively small adjustment can unleash much larger pent-up forces.

This means it may pay companies to pulse their advertising, concentrating it into relatively short periods of time, rather than spreading it evenly. It may also make sense for a company to roll out a new product region by region, concentrating its advertising where the product is new so as to spur adoption.

Just as an individual cannot solve five problems at once, most organizations concentrate on a few critical issues at any one time.

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.

(a) increase their mobility, that is, increase the options open to them and decrease the freedom of operation of the opponent’s pieces;

(b) impose certain relatively stable patterns on the board that induce enduring strength for oneself and enduring weakness for the opponent.

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

For example, when I work with a small start-up company, their problems often revolve around coordinating engineering, marketing, and distribution. Asking the CEO of such a firm to concentrate on opening offices in Europe may be pointless, because the company has not yet mastered the basics of “flying” the business. Once the firm stands firmly on that rung, it can move abroad and develop international operations. But, in turn, asking that newly international firm to move knowledge and skills around the world, as does a global veteran such as Procter & Gamble, may also be pointless. It must first master the complexity of operating in various languages and cultures before it can begin to skillfully arbitrage global information.

system has a chain-link logic when its performance is limited by its weakest subunit, or “link.” When there is a weak link, a chain is not made stronger by strengthening the other links.

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.

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.

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.

IKEA’s adroit coordination of policies is a more integrated design than anyone else’s in the furniture business. Traditional furniture retailers do not carry large inventory, traditional manufacturers do not have their own stores, normal retailers do not specify their own designs or use catalogs rather than salespeople, and so on. Because IKEA’s many policies are different from the norm and because they fit together in a coherent design, IKEA’s system has a chain-link logic. That means that adopting only one of these policies does no good—it adds expense to the competitor’s business without providing any real competition to IKEA. Minor adjustments just won’t do—to compete effectively with IKEA, an existing rival would have to virtually start fresh and, in effect, compete with its own existing business. No one did. Today, more than fifty years after IKEA pioneered its new strategy in the furniture industry, no one has really replicated it.

IKEA must perform each of its core activities with outstanding efficiency and effectiveness.

These core activities must be sufficiently chain-linked that a rival cannot grab business away from IKEA by adopting only one of them and performing it well. That is, a traditional furniture manufacturer that adds a ready-to-assemble line is no real threat to IKEA, nor is a traditional retailer that adds a catalog.

The chain-linked activities should form an unusual grouping such that expertise in one does not easily carry over to expertise at the others. Thus, a traditional furniture retailer that did add a catalog would still have to master design and logistics ...

When someone says “Managers are decision makers,” they are not talking about master strategists, for a master strategist is a designer.

My objectives are not to show my class how to manage a can company, or even how to create a good strategy. Instead, they are (1) to teach them how to identify a company’s strategy, (2) to deepen their skills at analyzing qualitative information, and (3) to explore a particular mixture of policy and positioning called focus. Crown’s

“Crown. By focusing on short runs, Crown avoids the captive squeeze. Instead of one customer with several competing suppliers, Crown is a supplier with several customers per plant. Going for long runs made the majors captive. Short runs turn the situation around. Crown hasn’t given up its bargaining power like the captives have.”

Crown and the majors are in the same industry but are playing by different rules. By concentrating on a carefully selected part of the market, Crown has not only specialized, it has increased its bargaining power with respect to its buyers. Thus, it captures a larger fraction of the value it creates. The majors, by contrast, have larger volumes of business but capture much lower fractions of the value they create. Thus, Crown crafted a

competitive advantage in its target market. It isn’t the biggest can maker, but it makes the most money.

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 overlapp...

“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.”

“You have done a fantastic job,” Susan replied. “You have created a wonderful new technology. No one can deny your skills at development—they are world class. But building a textile company, or a clothing company, is a completely different game.” The air in the room was taut with frustration. Susan might be right, but they wanted to move forward. Hadn’t they proved themselves? “Look,” Susan said, “it’s like this. You have won an Olympic gold medal in the 1,500-meter run. You have a good chance at winning the 10,000-meter run and I might back you at that. But you want to switch from running to wrestling gorillas. That’s not a good idea and I can’t back you at it.” Susan’s powerful image helped sway the team. They wanted to move ahead, but they certainly didn’t want to wrestle the gorilla.

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.

“How can I explain?” After a pause, he says, “By providing more value you avoid being a commodity. The bottled water field is crowded, but Lynda saw something unique in this product—water from a deep aquifer in Fiji that has been naturally filtered for several hundred years. Water that fell to earth before the industrial age, before pollution and chemicals. It is a unique proposition that the original owners had not exploited.”

The seven-to-ten-year lag in competitive response provided both the financing and a window of opportunity to build large-scale nut-processing facilities. The economies of scale in processing have so far prevented smaller competitors from achieving equivalent costs.

To see an example of a major competitive advantage that is, presently, not increasing in value, look at eBay.

Many strategy experts have equated competitive advantage with high profitability. The example of eBay (and of the imaginary silver machine) shows that this is not necessarily so. 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 im...

Deepening an advantage means widening this gap by either increasing value to buyers, reducing costs, or both.*

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.

Extending an existing competitive advantage brings it into new fields and new competitions. For example, cell phone banking is a growing phenomenon outside of the United States, especially in the less developed countries. eBay holds substantial skills in payment systems embedded in its PayPal business. If eBay could build on these to create a competitive advantage in cell phone payment systems, it would be extending a competitive advantage.

But now, in 1996, the basis of success in many areas was shifting to software—to the cleverness of chunks of code written by small teams. It was a shift from economies of size to the know-how and skill of single individuals. It was as if military competition suddenly shifted from large armies to single combat. A chill moved up and down my spine. There was the unnerving sense of hidden subterranean forces at work, twisting the landscape.

The two more mysterious shifts were the rise of software as a source of competitive advantage and the deconstruction of the traditional computer industry.

In particular, he described the “inflection” that had transformed the computer industry from a “vertical” to a “horizontal” structure.

It is hard to show your skill as a sailor when there is no wind. Similarly, it is in moments of industry transition that skills at strategy are most valuable.

Fortunately, a leader does not need to get it totally right—the organization’s strategy merely has to be more right than those of its rivals. If you can peer into the fog of change and see 10 percent more clearly than others see, then you may gain an edge.

The first guidepost demarks an industry transition induced by escalating fixed costs. The second calls out a transition created by deregulation. The third highlights predictable biases in forecasting. A fourth marks the need to properly assess incumbent response to change. And the fifth guidepost is the concept of an attractor state.

One type of accelerant is what I call a demonstration effect—the impact of in-your-face evidence on buyer perceptions and behavior. For example, the idea that songs and videos were simply data was, for most people, an intellectual fine point until Napster. Then, suddenly, millions became quickly aware that a three-minute song was a 2.5 megabyte file that could be copied, moved, and even e-mailed at will.

Organizational inertia generally falls into one of three categories: the inertia of routine, cultural inertia, and inertia by proxy.

The reaction to a request for demonstration code was as if Boeing engineers had been asked to design toy airplanes.

lack of response is not always an indication of sticky routines or a frozen culture. A business may choose to not respond to change or attack because responding would undermine still-valuable streams of profit. Those streams of profit persist because of their customers’ inertia—a form of inertia by proxy.

Similarly, one can sense a business firm that has not been carefully managed. Its product line grows less focused; prices are set low to please the sales department, and shipping schedules are too long, pleasing only the factory. Profits are taken home as bonuses to executives whose only accomplishment is outdoing the executive next door in internal competition over the bounty of luck and history.

Entropy is a great boon to management and strategy consultants. Despite all the high-level concepts consultants advertise, the bread and butter of every consultant’s business is undoing entropy—cleaning up the debris and weeds that grow in every organizational garden.

To put each location on a comparable basis, I devised a new measure of operating profit I called gain to operating (GTO) that adjusted for these differences and for various allocations.3 Denton’s best store had a GTO of $1.05 million and its worst had a GTO of negative $0.97 million. That is, closing that store would yield $0.97 million more per year than continuing to operate it. Denton’s whole chain showed a GTO of $0.32 million, a very different picture from the $8 million in net income the accounts showed.