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

by Richard P. Rumelt

cost of deciding to carry one more call every day for a year was still very close to zero. The cost of deciding to turn on the cable and carry thousands of calls every day for a year began to include maintenance and overhead expenses, but not the capital cost of the equipment. 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.

even faster than traffic grew.3 The collapse of prices could have been foreseen by anyone doing a simple Five Forces analysis. Why was this analysis ignored? Because the stock market promised something better. Consultants, investors, analysts, and strategists were beguiled by the market values of the new network operators. “Yes, their products look like perfect commodities,” one told me, “but something new is happening. The market is giving them a vote of confidence.” Thus, judgment fled.

The “axiom” of market accuracy anchors the circle’s center. In the fiber-optic business, this closure was sealed because analysts measured “growth” by looking at increases in installed capacity. Within that closed system, a question such as “Are transatlantic cables an overcapacity commodity business?” became what Kurt Gödel would call an un-decidable proposition. To answer this question one would have to look outside the closed system and make an independent estimate of the situation.

There was engineering overreach, where designers built systems whose failure modes and failure consequences exceeded their ability to comprehend or analyze. The new financial instruments created in the decade leading up to the 2008 crisis had failure modes no one understood or predicted.

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 ana...

There are many organizations and individuals working under risk-seeking incentives. Whenever you profit greatly if things go well and other people take the loss when things go poorly, you become a risk seeker.

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. 5. Finally, there is the inside view, a label given by Nobel laureate Daniel Kahneman and coauthor Dan Lovallo to the tendency to ignore related pertinent data—to believe that “this case is different.”7 The fourth and fifth problems—social herding and the inside view—deserve special attention, especially with regard to the 2008 financial crisis. An important virtue of a good leader is putting the situation in perspective and having cool-minded judgment. Both virtues help mitigate the bias inherent in social herding and the inside view. The inside view describes the fact that people tend to see themselves, their group, their project, their company, or their nation as special and different. Thus, for example, many people are aware of today’s outside-view statistic that talking on a cell phone while driving increases your accident risk by a factor of five—about the same as being drunk. But the inside view of the situation is “I am a good driver; those statistics don’t apply to me.” Similarly, we know that although most new restaurants fail, each entrepreneur thinks his or her new r...