THE STRATEGIST BE THE LEADER YOUR BUSINESS NEEDS Cynthia A. Montgomery Dedication To Anneke, Mathea, and Nils That you may find places where you can make a difference that matters And to Bjørn, forevermore Epigraph In the end, it is important to remember that we cannot become what we need to be by remaining what we are. —Max De Pree, CEO of Herman Miller, in Leadership Is an Art Contents Cover Title Page Dedication Epigraph Introduction - What I Learned in Office Hours Chapter 1 - Strategy and Leadership Chapter 2 - Are You a Strategist? Chapter 3 - The Myth of the Super-Manager Chapter 4 - Begin with Purpose Chapter 5 - Turn Purpose into Reality Chapter 6 - Own Your Strategy Chapter 7 - Keep It Vibrant Chapter 8 - The Essential Strategist Author’s Note Frequently Asked Questions Recommended Reading Notes Index Acknowledgments About the Author Credits Copyright About the Publisher Introduction What I Learned in Office Hours YOU’RE ABOUT TO get a revisionist view of strategy. It’s not that what you’ve learned is incorrect. It’s that it’s incomplete. Strategy is a fundamental course at nearly every business school in the world. I have been privileged to teach variations of it for more than thirty years—first at the University of Michigan, then at the Kellogg School at Northwestern, and for the last twenty-plus years at the Harvard Business School. For most of that time I worked with MBA students, until the center of my teaching shifted to executive education. It was this experience, particularly a five-year stint in Harvard’s Entrepreneur, Owner, President program (EOP), that inspired this book.1 Working intimately with leaders from nearly every industry and nation as they confronted their own real-world strategic issues changed not only how I teach strategy, but, more fundamentally, how I think about it. The experience led me to challenge some of strategy’s basic precepts, and ultimately to question both the culture and mind-set that have grown up around it. Even more important, teaching in EOP forced me to confront how strategy is really made in most businesses, and by whom. All of this convinced me that it is time for a change. Time to approach strategy in a different way and time to transform the process from a mechanical, analytical activity to something deeper, more meaningful, and far more rewarding for a leader. THE ROAD TO HERE Fifty years ago strategy was taught as part of the general management curriculum in most business schools. In the academy as well as in practice, it was identified as the most important duty of the president—the person with overarching responsibility for setting a company’s course and seeing the journey through. This vital role encompassed both formulation and implementation: thinking and doing combined. Although strategy had considerable depth then, it didn’t have much rigor. Heuristically, managers used the ubiquitous SWOT model (Strengths, Weaknesses, Opportunities, and Threats) to assess their businesses and identify attractive competitive positions. How best to do that, though, was far from clear. Other than making lists of various factors to consider, managers had few tools to help them make these judgments. In the 1980s and ’90s, my colleague Michael E. Porter broke important new ground in the field. His watershed came in firming up the Opportunities and Threats side of the analysis by bringing much-needed economic theory and empirical evidence to strategy’s underpinnings, providing a far more sophisticated way to assess a firm’s competitive environment. This led to a revolution in both the practice and teaching of strategy. In particular, managers came to understand the profound impact industry forces could have on the success of their businesses and how they could use that information to position their firms propitiously. Advances over the next few decades not only refined the tools but spawned a whole new industry. Strategy in many ways became the bailiwick of specialists—legions of MBAs and strategy consultants, armed with frameworks, techniques, and data—eager to help managers analyze their industries or position their firms for strategic advantage. In truth, they had a lot to offer. My own academic training and research in this period reflected this intellectual environment, and what I did in the classroom for many years thereafter was a living embodiment of this “new” field of strategy. In time, though, a host of unintended consequences developed from what in its own right was a very good thing. Most notably, strategy became more about formulation than implementation, and more about getting the analysis right at the outset than living with a strategy over time. Equally problematic, the leader’s unique role as arbiter and steward of strategy had been eclipsed. While countless books have been written about strategy in the last thirty years, virtually nothing has been written about the strategist and what this vital role requires of the person who shoulders it. It wasn’t until years into this shift that I fully realized what had happened. It was classic Shakespeare: As a field, we had hoisted ourselves on our own petard. We had demoted strategy from the top of the organization to a specialist function. Chasing a new ideal, we had lost sight of the value of what we had— the richness of judgment, the continuity of purpose, the will to commit an organization to a particular path. With all good intentions, we had backed strategy into a narrow corner and reduced it to a left-brain exercise. In doing so, we lost much of its vitality and much of its connection to the day-to-day life of a company, and we lost sight of what it takes to lead the effort. Teaching in the EOP program drove these insights home for me. When I first started working with the group, I used a curriculum that was much like one I would use in any executive program. Through a series of class discussions and presentations, we discussed the enduring principles of strategy, the frameworks that capture them, and a series of case studies that brought the concepts and tensions alive. We still do that—and it’s a valuable part of what we do. But in between class sessions, the EOP students—all accomplished executives and entrepreneurs— started to ask if they could meet me in my office to talk about various situations they were facing in their companies. These conversations often took place at unusual hours, and sometimes lasted far into the evening. Most started out predictably enough: We talked about the conditions in their industries, the strengths and weaknesses of their own companies, and their efforts to build or extend a competitive advantage. Some discussions ended there, and a thoughtful application of whatever we’d been doing in class seemed to meet the need. Often, though, these conversations took a different turn. Alongside all the conventional questions were ones about what to do when the limits of analysis had been reached and the way forward was still not clear; questions about when to move away from an existing competitive advantage and when to try to stay the course; questions about reinventing a business or identifying a new purpose, a new reason to matter. Even though many of the companies at issue were remarkably successful (one had grown from a start-up to $2 billion in revenue in just nine years), almost none had the kind of long-run sustainable competitive advantage that strategy books tout as the Holy Grail. Working with these managers, typically over three years, and hearing the stories within the stories, I came to see that we cannot afford to think of strategy as something fixed, a problem that is solved and settled. Strategy—the system of value creation that underlies a company’s competitive position and uniqueness—has to be embraced as something open, not something closed. It is a system that evolves, moves, and changes. In these late-night one-on-one conversations, I also saw something else: I saw the strategist, the human being, the leader. I saw how responsible these executives feel for getting things right. I saw how invested they are in these choices, and how much is at stake. I saw the energy and commitment they bring to this endeavor. I saw their confidential concerns, too: “Am I doing this job well? Am I providing the leadership my company needs?” And, more than anything, I saw in these conversations the tremendous potential these leaders hold in their hands, and the profound opportunity they have to make a difference in the life of a company. In those moments together, we both came to understand that if their businesses were going to pull away from the pack, to create a difference that mattered, it had to start with them. A NEW UNDERSTANDING In all our lives there are times of learning that transform us, that distance us from the familiar, and make us see it in new ways. For me, the EOP experience was one of those times. It not only changed some of my most central views about strategy; it gave me a new perspective on the strategist, and on the power and promise of that role. In these pages I will share with you what I have learned. In doing so, I hope that you will gain a new understanding about what strategy is, why it matters, and what you must do to lead the effort. I also hope that you will come to see that beyond the analytics and insights of highly skilled advisors and the exhortations of “how-to” guides, there is a need for judgment, for continuity, for responsibility that rests squarely with you—as a leader. Because this role rests with you, The Strategist is a personal call to action. It reinstates an essential component of the strategy-making process that has been ignored for decades: You. The leader. The person who must live the questions that matter most. That’s why my ultimate goal here is not to “teach strategy,” but to equip and inspire you to be a strategist, a leader whose time at the helm could have a profound effect on the fortunes of your organization. Author’s Note The examples and stories in this book are based largely on five years’ teaching in one of the comprehensive executive programs at Harvard Business School. In the pages of this book, I refer to this program as the Entrepreneurs, Owners, Presidents program (EOP), though the actual name of the program is different. You can find more information about various executive programs the school offers at www.exed.hbs.edu. In some cases, companies’ locations or certain details about them or individuals have been changed or composites of student experiences have been created so as not to violate the privacy of former students. Where names of companies or individuals are disclosed, it is done with express permission, and the details in the accompanying discussions have been approved for release by the firms. In some instances, I have presented cases in class in a different way than they are described here or used other cases than the ones in this book to make the same important points. Chapter 1 Strategy and Leadership Does your company matter? That’s the most important question every business leader must answer. If you closed its doors today, would your customers suffer any real loss?1 How long would it take, and how difficult would it be, for them to find another firm that could meet those needs as well as you did? Most likely, you don’t think about your company and what it does in quite this way. Even if you’ve hired strategy consultants, or spent weeks developing a strategic plan, the question probably still gives you pause. If it does or if you’re not sure how to respond, you’re not alone. I know this because I’ve spent the better part of my life working with leaders on their business strategies. Again and again, I’ve seen them struggle to explain why their companies truly matter. It’s a difficult question. Can you answer it? If you cannot, or if you’re uncertain of your answer, join me as I explore this question with a group of executives now gathering. It is evening on the campus of the Harvard Business School. The kickoff orientation to the Entrepreneur, Owner, President program (“EOP” for short), one of the flagship executive programs at the school, is about to begin. Along with five of my fellow faculty, I sit in the “sky deck,” the last and highest row of seats, in Aldrich 112, an amphitheater-style classroom characteristic of the school, and watch as the newest group of executives stream into the room. I see that there are considerably more men than women, and that the majority appear to be in their late thirties to mid-forties. Most exude an air of seasoned self-confidence. That’s no surprise—they’re all owners, CEOs, or COOs of privately held companies with annual revenues of $10 million to $2 billion— the kind of small- to medium-size enterprises that drive much of the global economy. Most arrived on campus within the last few hours and have had just enough time to find their dorm rooms and meet the members of their living groups before heading here to Aldrich. The information they provided in their applications tells part of their stories: Richard, a thirdgeneration U.S. steel fabricator; Drazen, CEO of a media firm in Croatia; Anna, founder and head of one of the largest private equity groups in South America; and Praveen, the scion of a family conglomerate in India. But this is just a taste of their diversity and accomplishments. The richer details and the breadth of the class will emerge in the weeks ahead. As the clock ticks past the hour, some last-minute arrivals burst through the door. They are typical firsttime EOPers in their lack of concern about being late. Most of these people hail from worlds where meetings don’t start until they arrive. That will change in the coming days, as they make the adjustment from the top-of-the-line leather chairs in their offices back home to the standard-issue seats that line the classrooms. Indeed, for their time here, they will be without many of the supports they rely on in their daily lives, such as administrative assistants and subordinates to whom they can delegate work and problems. Families are strongly discouraged from living near campus and are prohibited from dorms once classes begin. BlackBerrys and cell phones are allowed, but never in class. A final hush settles as the program begins with an overview of who’s here: 164 participants from thirtyfive countries, with a collective 2,922 years of experience. Two-thirds of their businesses are in service industries, the remainder in manufacturing. They are here to participate in an intensive management boot camp for experienced business leaders. It spans topics in finance, marketing, organizational behavior, accounting, negotiations, and strategy, and runs for nine weeks in total, divided into three three-week sessions spread over three years. Between sessions, students return to their businesses and start to apply what they have learned. Debriefs the following year are an opportunity for feedback and reflection on what has worked and what hasn’t. This structure has given the faculty an exceptional opportunity to develop a hands-on curriculum that brings theory and practice much closer together, even for a school that has always championed the connection. Why do these talented, seasoned managers from every major world culture come to this program? As heads of their companies, why do they elect to spend tens of thousands of dollars to send themselves to school? THE VIEW FROM THE BALCONY If past participants are any indication, these executives have not come to seek specific answers to narrow questions. They have come to learn how to be more effective leaders and to find ways to make their businesses more successful. Successful in what ways, and through what means, for most, is still an open question. They are here to throw themselves into the program, to be challenged, to discover what they might learn in this environment. This experience will be an important juncture for many, in their careers and even their lives. What they learn here will lead them to think in broader, more far-reaching ways. To explain how this happens, I’ve always liked the metaphor of a dance taking place in a great hall.Most dancers spend all their time on the dance floor, moved by the music, jostled by dancers around them, completely absorbed in the flow. But it’s not until they extricate themselves from the crowd and move to the balcony above that the larger picture becomes clear. It is then that overall patterns become apparent and new perspectives emerge. Often these reveal opportunities for better choices about what to do down on the dance floor. Many EOPers have spent years without ever leaving the dance floor. Absorbed by the day-to-day challenges of running a business, they’ve never gone to the balcony. On one level, our job is to help them understand the value of going to the balcony in the first place. On another, it is to equip them with the tools to see their dances in new ways, ways that reveal options they may never have considered before. THE STRATEGY COURSE When it’s time for the faculty to introduce their courses, I stand and give a quick summary of the work we’ll be doing in strategy. Like most businesspeople, these managers are likely to be familiar with at least a vague definition of strategy. The word itself comes from the ancient Greek for “general”—specifically for the general on campaign in the field. In business, strategy is a company’s campaign in the marketplace: the domain in which it competes, how it competes, and what it wants to accomplish. We will begin our journey with the fundamentals—what strategy is, how to craft it, and how to evaluate it. We’ll then push the envelope on current practice by challenging strategy’s elusive goal—the long-run sustainable competitive advantage—and introduce a dynamic model of strategy that is better grounded and better suited for the competitive realities most managers face. All of this material is prelude to the last and most challenging task they will face here, when every member of the class will be asked to apply the concepts and frameworks we’ve been studying to their own companies and present their own strategies for critiquing by their EOP colleagues. The exercise takes many days and, in the end, the class votes on a winner, what they consider the “best strategy” in the group. This step from the general to the highly particular, from the objective to the subjective, is where things become profoundly real for most executives. This is when the appraisals of cases—now their cases—get deadly serious and the discussions especially heartfelt. These are competitive people. A spirit of intense rivalry prevails. Most refine their strategies through multiple iterations, often working through the night for one more iteration. These weeks are arduous for some, exhilarating for others, and, for most, a healthy mix of both. GETTING TO THE REALITY OF YOUR STRATEGY Having seen hundreds if not thousands of such strategies in their initial form, what is clear to me is this: Many leaders haven’t thought about their own strategies in a very deep way. Often, there is a curious gap between their intellectual understanding of strategy and their ability to drive those insights home in their own businesses. Some EOPers find it extremely difficult to identify why their companies exist. Accustomed to describing their businesses by the industries they’re in or the products they make, they can’t articulate the specific needs their businesses fill, or the unique points that distinguish them from competitors on anything beyond a superficial level. Nor have they spent much time thinking concretely about where they want their companies to be in ten years and the forces, internal and external, that will get them there. If leaders aren’t clear about this, imagine the confusion in their businesses three or four levels lower. Yet, people throughout a business—in marketing, production, service, as well as near the top of the organization—must make decisions every day that could and should be based on some shared sense of what the company is trying to be and do. If they disagree about that, or simply don’t understand it, how can they make consistent decisions that move the company forward? Similarly, how can leaders expect customers, providers of capital, or other stakeholders to understand what is really important about their companies if they themselves can’t identify it? This is truly basic—there is no way a business can thrive until these questions are answered. Even so, the exercises in EOP are designed to do more than set high standards, communicate concepts, and improve participants’ existing strategies. The overarching goal is something different, something deeper and more personal. It is to make clear to these executives that strategy is the heart of the ongoing leadership their companies need from them. That’s why competition for “best strategy” is so hard fought and generates so much energy. CEOs, accustomed to asking questions and being deferred to, are challenged by their peers and encouraged to think and rethink parts of their strategies they’d taken for granted. Most of them describe it as a pivotal experience that fundamentally changes their views of their own businesses. Behind the scenes, though, the real contest is closer in: It’s each of these leaders pushing their own ideas to the increasingly high standards they themselves have come to demand of excellent strategies and of themselves as leaders. It’s that process, more than any short-term answers they might find here, that will serve them well in the long run. LEADERSHIP AND STRATEGY ARE INSEPARABLE Many leaders today do not understand the ongoing, intimate connection between leadership and strategy. These two aspects of what leaders do, once tightly linked, have grown apart. Now specialists help managers analyze their industries and position their businesses for competitive advantage, and strategy has become largely a job for experts, or something confined to an annual planning process. In this view, once a strategy has been identified, and the next steps specified, the job of the strategist is finished. All that remains to be done is to implement the plan and defend the sustainable competitive advantage it has wrought. Or at least that’s the positive take on the story. But, if this were so, the process of crafting a strategy would be easy to separate from the day-to-day management of a firm. All a leader would have to do is figure it out once, or hire a consulting firm to figure it out, and make sure it’s brilliant. If this were so, the strategist wouldn’t have to be concerned with how the organization gets from here to there—the great execution challenge—or how it will capitalize on the learning it accumulates along the way. But this is not so. What’s been forgotten is that strategy is not a destination or a solution. It’s not a problem to be solved and settled. It’s a journey. It needs continuous, not intermittent, leadership. It needs a strategist. Good strategies are never frozen—signed, sealed, and delivered. No matter how carefully conceived, or how well implemented, any strategy put into place in a company today will eventually fail if leaders see it as a finished product. There will always be aspects of the plan that need to be clarified. There will always be countless contingencies, good and bad, that could not have been fully anticipated. There will always be opportunities to capitalize on the learning a business has accumulated along the way. The strategist is the one who must shepherd this ongoing process, who must stand watch, identify and weigh, decide and move, time and time again. The strategist is the one who must decline certain opportunities and pursue others. Consultants’ expertise and considered judgments can help, as can perspectives and information from people throughout an organization. But, in the end, it is the strategist who bears the responsibility for setting a firm’s course and making the choices day after day that continuously refine that course. That is why strategy and leadership must be reunited at the highest level of an organization. All leaders —not just those who are here tonight—must accept and own strategy as the heart of their responsibilities. I say little of this tonight in the classroom. But it is on my mind as I return to my seat in the sky deck and reflect on all the would-be strategists I’ve worked with over the years as well as those of you who are just starting out. My hope is that you will come not only to understand the vital role of the strategist, but also to embrace it for yourself. Five years ago, when I first started teaching in EOP, I heard the program described as challenging and transformative. At the time, “challenging” struck me as right, but “transformative” seemed closer to hype. Having seen it happen again and again, I now share the optimism. As our orientation session draws to a close, I join the executives and fellow faculty as we head en masse to Kresge Hall for cocktails and dinner. Our work is about to begin in earnest. In all my classes, I pose one fundamental question: “Are you a strategist?” Sometimes it’s spoken, often it’s only implicit, but it’s always there. We talk about the questions strategists ask, about how strategists think, about what strategists do. My intent is not to coach these executives in strategy in the way they might learn finance or marketing. As business heads, they aren’t going to be functional specialists. But they do need to be strategists. Are you a strategist? It’s a question all business leaders must answer because strategy is so bedrock crucial to every company. No matter how hard you and your people work, no matter how wonderful your culture, no matter how good your products, or how noble your motives, if you don’t get strategy right, everything else you do is at risk. My goal in this book is to help you develop the skills and sensibilities this role demands, and to encourage you to answer the question for yourself. It’s a difficult role and it may be tempting to try to sidestep it. It requires a level of courage and openness to ask the fundamental questions about your company and to live with those questions day after day. But little you do as a leader is likely to matter more. Chapter 2 Are You a Strategist? HERE’S A TEST of your strategic thinking. It’s the same one I give my EOPers right at the beginning of the course. Step into the shoes of Richard Manoogian, CEO of Masco Corporation, a highly successful company on the verge of a momentous decision.1 You’ve got a big pile of money and must decide whether to invest it in a far-reaching new business venture. The stakes are high, and it’s not an easy or obvious decision. If you don’t go ahead, you could be passing up an opportunity for growth in a new direction and hundreds of millions of dollars in future profits. If you take the plunge and turn out to be wrong, you may have wasted $1–2 billion. Either way, you will have to live with the results for many years. To make the decision, you’ll first need to know something about Masco and its marketplace. The story begins more than two decades ago, but its lessons are timeless, and the intervening years allow us to take a long view on the company and the industry. FIRST, CONSIDER THE COMPANY It’s 1986. Masco is a successful $1.15 billion company that has just recorded its twenty-ninth consecutive year of earnings growth. Its ability to wring outsized profits out of industries that are neither high tech nor glamorous has won it the monicker of “Master of the Mundane” on Wall Street. Its portfolio includes faucets, kitchen and bathroom cabinets, locks and building hardware, and a variety of other household products.2 Masco expects the businesses to generate $2 billion in free cash flow over the next few years. What would you do with all that money? Masco’s leaders want to tackle other mundane businesses where their prowess can “change the game.” They envision becoming the “Procter & Gamble of consumer durables.” In their immediate sights is the U.S. household furniture business, where they see another opportunity to seize profitable dominance of a sleepy industry. Is Manoogian’s idea a promising one? If so, is Masco the company to lead the charge? When I raise these questions the first morning in class, the executives don’t immediately jump up. Like you, they enjoy being the decision maker; it’s the role they play in their real-life jobs, but they’re reluctant to put themselves on the line with a group they’ve just met. With some coaxing, though, we’re soon deep into Masco’s situation and the issues Manoogian faces. The case for Manoogian’s strategy looks compelling. Through a long record of triumphs in durable goods industries, Masco distinguished itself through efficient manufacturing, good management, and innovation. Its biggest success to date was reinventing the faucet business. Prior to Masco’s entry, the industry was highly fragmented and had a general lack of brand recognition, minimal advertising, and a low level of salesperson training. Leveraging the company’s deep metalworking expertise, garnered in its early years as a supplier to the automotive industry, Masco’s founder, Richard’s father Alex, solved an engineering problem that made one-handle faucets workable. When he couldn’t interest faucet companies in his patented innovation, Masco began making and selling the faucets itself. Homeowners loved them, finding them a big improvement over traditional faucets that forced users to fiddle with hot and cold water separately. This extra functionality was particularly valued in kitchens where utility and maintenance-free operation were important. Not neglecting two-handle faucets, the company introduced a model with a new type of valve. This design, also patented, eliminated rubber washers, the major cause of faucet failure. Masco went on to innovate in many other aspects of these new products, from basic manufacturing to distribution and marketing. It was the first to create brand recognition for a faucet with its Delta and Peerless brands. It was the first to introduce see-through packaging, to market faucets direct to the consumer through the do-it-yourself channel, and to advertise faucets on TV during the Olympics. In refashioning an industry of “me-too” products and boldly setting itself apart from others, Masco demonstrated that it was creative, able to apply traditional capabilities in new ways, and willing to take risks and make them pay off—abilities Richard Manoogian hoped would enable him to transform the furniture business. NOW CONSIDER THE INDUSTRY At the time Manoogian was weighing this decision, household furniture was a $14 billion business in the United States that didn’t make much money. With high transportation costs, low productivity, and eroding prices, it had about 2 percent annual growth, and return on sales, on average, was about 4 percent. There were more than 2,500 manufacturers, but 80 percent of sales came from only four hundred. Not all players were small, but most were, and many were family firms that had stuck it out through thick and thin, reluctant to leave the only livelihood their families had known for generations. Making matters worse, both sales and profits were cyclical and tied to broad economic factors such as new home starts and sales of existing homes. Management in the industry was generally regarded as unsophisticated, and hadn’t made many significant changes in the previous fifty years. Wesley Collins, a furniture executive and trenchant observer of industry conditions, summed it up dramatically: When everything else in our lives was changing, furniture stood its ground. While we put a man on the moon . . . furniture put another steak on the backyard grill and muttered, “My god, the price of oak went up again.” When videotape put the home movie camera in the trash can forever, and tape cassettes put the plastic record-maker six feet under, and word processors put typewriters in the closet, and microwave popcorn killed the makers of popcorn makers . . . the furniture industry said, “Thanks, but we’ll stand pat.” While we sat on our tuffets, the consumer forgot all about us. Our share of consumer expenditures slipped year after year. We lost over 40 percent of the retail furniture space in America, 25 percent of the retailers shut their doors, and department stores discontinued furniture right and left for products that gave them a better ratio of margin and turns per square foot.3 Collins went on to say that “the average tobacco chewer spends more for Levi Garrett Chewing Tobacco every year than he does for furniture.” Most furniture purchases were discretionary and highly postponable, and, as Collins noted, there were many substitutes and lots of competition for the customer’s dollar. New innovations and designs were quickly knocked off by competitors, eliminating any advantage the innovators might have momentarily enjoyed. Equally distressing, in the United States, there was little brand recognition in the industry. Customers didn’t know much about furniture and weren’t motivated enough to find out. There was little advertising and consumer research had shown that many American adults could not name a single furniture brand. Think for a minute: “What brand of sofa do you have in your living room?” When I pick an executive in the class at random and ask this question, the response is usually a startled look, a long moment of silence, and then, something like “Brown leather?” Everyone laughs, but when I open the question to the entire class, only a few hands go up and they’re inevitably executives from Europe. Yet when I ask how many of them know the brand of car their neighbors drive, virtually all hands go up. Yours probably would, too. On top of its marketing challenges, the industry was riddled with inefficiencies, extreme product variety, and long lead times that frustrated customers. Buyers often received partial shipments; for example, a dining table might arrive weeks or months before the chairs that went with it. The real issue, though, is not whether there are problems in the industry but what they mean. Are all these problems an opportunity for a courageous company with the right skills? Or are they red flags warning outsiders to stay away? When I ask my executives whether they would take the plunge, most respond with a resounding “Yes!” They’re energized, not intimidated, by the challenges. Most say, in effect, “Where there’s challenge, there’s opportunity.” If it were an easy business, they say, some company would already have seized the opportunity: It would be much tougher to dislodge a strong leader than to gain ground in an industry like this where there are no big players, no Microsofts already established. “It’s a horse race,” someone once said, “and all the other horses are slow.” Further, they note, the furniture industry is much like the faucet industry before Masco entered. The opportunity is a great fit with Masco’s manufacturing skills, its marketing savvy, and its strong management capabilities. It’s another chance for Masco to bring money, sophistication, and discipline to a fragmented, unsophisticated, and chaotic industry. Opponents can’t get past how awful the furniture business is. They can’t imagine any company overcoming such huge hurdles. So the arguments go back and forth. Enthusiasm and a gung-ho spirit on one side struggle against caution and concern on the other. In one discussion, an exasperated proponent blurted out, “Look, this isn’t about being passive investors in some yet-to-be-invented furniture industry index fund. We’re going to be players in this game. We can make things happen. If Starbucks or Under Armour had listened to you naysayers, they wouldn’t have done anything!” What’s your inclination at this point? Usually when the time comes for a decision in my classes, “Do it” wins definitively, by at least a 2-to-1 margin. So what, in fact, happened? Masco did enter and in a bold way. Over two years, it bought Henredon (high-end furniture) for $300 million, Drexel Heritage (mid-price) for $275 million, and Lexington Furniture (low–middle) for $250 million. Combined, the revenues from the three made Masco the second-largest player in the U.S. furniture industry. It followed up by spending $500 million for Universal Furniture Limited (low end), which had manufacturing operations in ten countries on three continents and followed a ready-to-assemble concept—component parts were manufactured in low-cost countries and shipped in containers to five U.S. locations for assembly. Now Masco was both the largest furniture company in the world and one of the only firms with products spanning nearly every price point, a strategy that had worked well for the firm in faucets. In total, Masco spent $1.5 billion acquiring ten companies and another $250 million upgrading their manufacturing facilities and investing in new marketing programs. Presenting Manoogian with its Gold Award in the Building Materials Industry, the Wall Street Transcript cited his imagination, foresight and strategic sense. . . . Manoogian has acquired low growth, mature products and become the dominant player in those product categories. . . . [H]is most recent set of acquisitions has been in the furniture industry. His strategy is to do to the furniture industry what he did to the faucet and kitchen cabinet industry. . . .4 With this historical update, the classroom crackles with energy. Executives who had advocated for bold action nod their heads to one another or give each other high-fives and thumbs-up, pleased that they’ve nailed their first Harvard case. I hear little “told-you-so” comments directed at the naysayers, who sit in grim silence. Someone once even called across the room: “Don’t worry, Bob. One bad decision won’t ruin your reputation. We won’t hold it against you the rest of the program.” But it doesn’t take long for those who opposed entry to speak up. “But how did Masco do?” “They bought great brand names,” says someone. “But how did they do?” “They’re number one in market share. What more do you want?” “But did they make money?” There, as it’s said, is the rub. When I post Masco’s financial results, silence falls as people absorb the numbers. In a few seconds, there are whispered expletives around the room. After thirty-two years of consecutive earnings growth, Masco’s net income fell 30 percent. Two years later, operating earnings from furniture came to $80 million on sales of $1.4 billion, an operating margin of 6 percent, versus 14 percent for the rest of the company. After many years of struggle, Masco announced its intentions to sell its furniture businesses, leading one analyst to comment: In the spring, management will go on the road with restated financials illustrating their “core” earnings growth as if they never entered the furniture business. They hope to rebuild investor confidence in the old [pre-furniture] Masco . . . as a growth company by showing their track record and prospects in the building materials arena. Given the $2 billion furniture “mistake,” this won’t be easy. In a sad postscript, Masco discovered that exiting the furniture business was much harder than entering it. After a number of deals fell through, it eventually succeeded in selling its furniture firms, at a loss of some $650 million.5 When it was all over, CEO Manoogian admitted, “The decision to go into the home furnishings business was probably one of the worst decisions I’ve made in 35 years.”6 It’s a sobering moment in the classroom. The executives there didn’t intend to open their careers at the Harvard Business School by losing hundreds of millions of dollars their first morning. So, let me ask you again, as I do the managers in my class: “Are you the strategist your business needs?” Chapter 3 The Myth of the Super-Manager AS A STRATEGIST, what can you learn from Masco’s foray into furniture and the support most executives give that ill-fated decision? Even if you were undecided or skeptical about the furniture industry, I’m willing to bet that some part of you supported Masco’s move. No one respects timid, passive managers. Bold, visionary leaders who have the confidence to take their firms in exciting new directions are widely admired. Isn’t that a key part of strategy and leadership? In truth, it is. But the confidence every good strategist needs can readily balloon into overconfidence. A belief that is unspoken but implied in much management thinking and writing today is that a highly competent manager can produce success in virtually any situation. One writer calls this “the sense of omnipotence that plagues American management, the belief that no event or situation is too complex or too unpredictable to be brought under management control.”1 I call this belief, when taken to its extreme, the myth of the super-manager. It seems to come naturally to many successful entrepreneurs and senior managers who see themselves as action-oriented problem solvers, confident doers for whom difficulties are daunting but solvable challenges. I see it behind Masco’s leap into furniture manufacturing and behind executives’ choice of the same path every time I teach the case. Confidence matters. But there’s much more to strategy and leadership than a steadfast belief that a daring vision backed by good management can overcome virtually all obstacles. Without the rest of it, “bold” too often becomes “reckless.” Look at what such thinking did to Masco. Operating profitability dropped to half its historical average, and the firm’s stock price was lower when it left the furniture industry than when it entered ten years earlier. And money was only part of the cost. Where Wall Street had spoken of Masco as a “Master of the Mundane,” it began to speak of the company’s “past glory” and “bitter shareholders.”2 The company lost momentum as its leaders spent years distracted by a massive venture that ultimately failed. For Masco, its move into furniture was a defining moment, but not a positive one. A legacy built over decades was shattered, an affirmation of a well-known Warren Buffett maxim: “It takes twenty years to build a reputation and five minutes to ruin it.” All because the strategist got this one choice wrong. What happened? Your instinct, like most managers’, is probably to seek the answer by looking at Masco itself and its leaders. Surely, the ultimate fault lies there. But to get the full picture, you must look as much outside as inside the firm. Here is a first clue. As our faculty team was preparing to teach the case for the first time, a colleague, the most senior in the room, said, “Wait a minute. This story sounds very familiar.” He left the meeting and went back to his office files. There he found “Mengel Company (A),” a case so old it was typed on onionskin paper. Set in 1946, the Mengel case describes the firm’s plans to revolutionize the highly fragmented furniture industry. Mengel’s bold idea? Build scale, gain efficiencies by leveraging its manufacturing skills, and establish brand identity. To do this, it would buck industry practice and spend $500,000 on national advertising to “make the average consumer style-conscious” and build its “Permanized” brand name.3 I had never heard of Mengel, but with an eerie sense of déjà vu, I wondered if Masco’s leaders had known about them. My own research in the industry led to the following list. What do you think these seemingly disparate companies have in common? Consolidated Foods Champion International Mead General Housewares Ludlow Intermark Georgia Pacific Beatrice Foods Scott Paper Burlington Industries Gulf + Western Like Mengel and Masco, these are all companies that tried and failed to find fortune in furniture manufacturing. Most were regarded as well-run companies. Like Masco, they considered a fragmented, chaotic industry to be an opportunity for good managers to apply their skills. With great expectations and high hopes of success, they all jumped in with the intention of reshaping the industry through the infusion of “professional management.” Years later, they all left. UNDERSTANDING THE FORCES Most executives find this list both revealing and disconcerting. These were companies with considerable track records, yet they all failed in the same endeavor. Was there something problematic about the endeavor itself? Was something at work in the furniture industry that was outside the control of these companies and their leaders? Here’s another clue. Look at the chart on Relative Industry Profitability. It shows the average return on equity for twenty industries over the twenty-year period from 1990 to 2010. The chart was compiled from Standard & Poor’s and Compustat databases that include data on all companies that traded on U.S. stock exchanges. Are you surprised by how much profitability varies by industry? Compare Tobacco companies at 36.1 percent average annual return on equity—which means leading firms in the industry do even better—with Airlines at -10 percent or Commercial Equipment at -2 percent. In my experience, most executives understand that average profitability will differ from industry to industry, but the scale of variation often comes as a surprise. Annual average returns in the most profitable industries are well more than double those in median industries, and more than four or five times those at the bottom of the distribution. Researchers have found similar differences in other countries, in both advanced and emerging economies.4 Are these vast differences from industry to industry caused by random variation? It’s not likely— they’re too large and too consistent. Do some types of businesses attract great managers while others attract only poor ones? Sometimes, but not enough to account for the differences. In fact, these variations are caused by economic forces that shape each industry’s competitive landscape differently.5 As Michael Porter has shown, some of these relate to the nature of rivalry within the industry itself; others have to do with the balance of power between the industry and its suppliers and customers, substitute products, and potential new entrants. Sometimes the forces are fierce and lead to low levels of industry profitability; other times they’re relatively benign and set the scene for much more profitable outcomes. The collective impact of these forces on the profitability of individual firms, and, in turn, on industries in which they operate, is called the industry effect. You may be surprised to learn that some and perhaps much of your company’s performance is determined by such forces.6 These competitive forces are beyond the control of most individual companies and their managers. They’re what you inherit, a reality that you have to deal with. It’s not that a firm can never change them, but in most cases it’s very difficult to do. The strategist’s first job is to understand them and how they affect the playing field where competition takes place. MAKING THE DISTINCTIONS As suggested by the above chart, industries can be arrayed along a continuum extending from “Unattractive” to “Attractive,” where attractiveness refers to the degree to which industry competitive forces restrict, allow, or even foster firm profitability. The table below identifies the most important of these economic forces and characterizes what they probably would be like in industries at the bounds of such a continuum.7 Unattractive.......... High. Many homogeneous competitors and Rivalry among firms homogeneous products. Innovations quickly copied. Slow growth. Excess capacity. Price competition. High. Industry is dependent on a few, concentrated suppliers producing unique products, and Industry is not important source of profitability to suppliers. Power of suppliers High. Customers have lots of choice among Power of customers similar products. Low levels of brand awareness. Low switching costs. Low levels of emotional involvement with purchase. Low. Industry is easy to enter and sometimes Barriers to entry and exit difficult to exit, creating excess capacity. Strategies of existing competitors can be easily replicated or surpassed. Entry requires low levels of capital, modest scale, and no scarce or specialized resources. High. Wide variety of compelling substitute products are available that meet customers’ needs at attractive relative prices. Availability of substitute products ............to Attractive Low. One or a few dominant, differentiated players. Unique products. Strong brand identities. Rapid industry growth. Shortage of capacity. Low. Many suppliers producing homogeneous products. Price competition and plentiful supply make it easy to procure supplies at reasonable cost. Low. Products are scarce, highly differentiated, and important to customers’ well-being. Customers have limited choice. Brands are strong. High. It is difficult or not economical for new firms to enter your industry. Entry requires economies of scale, product differentiation, high capital investment, regulatory approval, or accumulation of special expertise or experience. Low. Customers have few or no choices of alternative products that could meet their needs at comparable prices. Note how closely many of the competitive conditions in furniture manufacturing mirror those in the lefthand “Unattractive” column. • Rivalry among furniture firms is intense, as shown by the high number of firms making similar furniture and by the ability of firms to copy innovations made by competitors. • Suppliers to the furniture industry, such as textile makers, dominate the vendor relationship because no furniture company buys enough textiles to be an important customer. • Customers in the industry are powerful because furniture purchases are highly postponable, products are long-lived and commodity-like, and customers are not brand sensitive. • Entry barriers are low, meaning that new firms can flood in and pull down prices if industry conditions ever become more attractive. On the other hand, the industry can be difficult to exit, especially for the many family firms that have few alternative options, making excess capacity slow to leave the industry. • Substitute products abound. New furniture must compete for the customer’s dollar with countless alternatives—including used furniture or hand-me-down furniture passed from user to user. Since many customers consider furniture a discretionary purchase, it must also compete with a plethora of products such as televisions and sound systems that customers are more excited about and consider to be a better value for their discretionary dollars. Even when furniture prices lagged increases in the consumer price index, sales did not respond. How do you react to the existence of these forces? It isn’t a happy lesson for many executives I teach. It seems to say, “Your prospects are predetermined —the game is up—or, if not up, a big chunk of it is out of your control.” Action-oriented executives, I find, prefer not to think of themselves as in the grip of outside forces. They prefer to believe in free will, not determinism. The possibility that their industries might drive or heavily influence their own performance isn’t near the top of their minds. As proactive leaders and believers in the power of management, they tend to focus on what they can control, while ignoring or underestimating what they cannot. REJECTING THE MYTH Ironically, the most successful and admired leaders, the titans of business, understand the profound significance of competitive forces outside their control. They know the crucial importance of picking the right playing field. They don’t buy the management myth that a truly good manager can prevail regardless of the circumstances. Look at Jack Welch, Fortune magazine’s “Manager of the Century.” You probably don’t remember that when he took over General Electric, Welch sold off more than 200 businesses worth more than $11 billion and used that money to make more than 370 acquisitions. Why? He wanted out of industries where conditions were too negative, where he thought it would be too hard for GE to flourish. “I didn’t like the semiconductor business,” he said. “I thought it was too cyclical and it required too much capital. There were some very big players in it and only one or two were making any money on a sustained basis. . . . [Exiting that business] allowed us to put our money into things like medical equipment, power generation, all kinds of industries where we changed the game. . . .”8 A comment from the Sage of Omaha himself, Warren Buffett, caps the point: When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.9 Buffett and Welch, two of the strongest managers on record, recognize that industry matters a lot. They understand that a significant measure of a firm’s success depends on competitive forces beyond a manager’s control, and they use that knowledge to their own advantage—by picking playing fields where they can win and, within those fields, carefully positioning their businesses to work with, not against, the forces. BUT WHAT ABOUT . . . ? Despite such counsel, the myth of the super-manager lives on for many executives. It’s reinforced in practice just often enough to give it credence. Sometimes, even in the toughest lines of business, there is a plan that works. Individual firms on occasion have not only achieved great success in industries where most others have failed, but they’ve even changed the basic competitive context of the industries. Such stories receive inordinate attention in business books and media, and executives are always quick to bring them up: Starbucks’s revolution in the coffee house business. Southwest’s triumphs in discount airlines. Cirque du Soleil’s reinvention of the circus business. Even Masco’s coup in faucets. Yes, it does happen. But none of these strategies appeared out of the blue from the unfettered minds of super-managers. They came from a deep comprehension of the industries involved and the conditions at work in them. The founders of Southwest discovered a way to exploit a hole in the fare and route structures of established competitors. Starbucks succeeded not simply by brewing better coffee and creating an attractive coffee house experience, but by gaining scale and building the unique corporate skills needed to replicate that experience not tens or hundreds but thousands of times. The founders of Cirque du Soleil, performers themselves, understood the essence of the traditional circus—that it was focused on children and that its economics were badly strained by the expense of transporting and caring for large, wild animals. By focusing on an adult audience, which let them drop many of the animal acts, they skillfully positioned themselves to avoid one of the industry’s greatest drains on profits while targeting customers with the highest willingness to pay.10 That’s not a cavalier disregard for industry forces: It’s surgical precision. Look, too, at Warren Buffett’s portfolio. Most people don’t know he’s made significant investments in furniture. Like Masco, he also saw potential in the industry. But Buffett chose to invest in furniture retailing, not manufacturing, and bought several successful furniture sellers around the United States. He seems to be experimenting to see if these downstream retailers can benefit from the intensely competitive conditions upstream in furniture manufacturing—the very conditions that brought down Masco, Mengel, and all the others. In the long run, these may not turn out to be Buffett’s most brilliant ventures, but they reveal a real strategist playing his cards carefully with a deep appreciation of the forces at work in the industry. No one can say that the decision to enter or remain in a tough industry is right or wrong on the face of it. Remaking a difficult business, as Masco set out to do, isn’t easy, but as we’ve seen, it can and has been done. When it works, though, it’s always a two-sided affair: It involves an industry, or part of an industry, that can be changed and a firm with a viable way to do so. THE MISSING INFORMATION What does all this tell you about Masco and its failed furniture venture? For the full answer, we must look more closely at Masco’s actions and at how most of my students— people much like you, I suspect—saw only the upside potential of the opportunity. After a class has voted for Masco to enter furniture manufacturing (and they always do), I ask the strongest proponents of the move how the firm should proceed. What specific actions should Masco’s managers take that will cause it to perform above the average in its new line of business? Alongside the bold decision to enter, the proponents’ plans usually look surprisingly lackluster. Nearly all of them start with “Masco should acquire . . .” and go on to add some grand but vague statements about rationalizing production, improving efficiency, leveraging the company’s professional management, using “power marketing,” and so on. When I want to know what the company would do differently, how “professional management” would work here, or what would set the firm apart from others, the answers get progressively vague and superficial. They haven’t thought about all that. What becomes clear is that their arguments are propelled by an enthusiasm for the company itself, for what it’s achieved in the past, and for the storehouse of capabilities it could bring to a new venture. What is missing is a specific plan that shows why all of that will matter in this industry, and how it will neutralize the long-lived forces that have broken so many other firms. These discussions always remind me of how French generals after World War I responded to the fact that, in the previous half century, Germany had twice defeated French armies. The generals took a number of steps, including construction of the now-infamous Maginot Line, but a key reason, they said, that France would not be defeated again was the élan vital of the French soldier. Élan vital means “vital spirit” and the gist of French thinking was that the superior determination or attitude of the French army would defeat whatever the Germans threw at it. Of course, we know how well that worked. It was the military equivalent of the myth of the super-manager. Masco’s vital spirit wasn’t enough, either. Its leaders hoped its superior management and manufacturing skills would lead it to victory on a new front, and that the same strategy that had brought it great success in faucets would do the same in furniture. But, while similar in some ways, the two industries were different in other ways that Masco either failed to notice or appreciate. Masco’s purchases of furniture companies at three price points—low, middle, and high—reflected its belief that significant scope economies, or savings that come from producing a wide range of products, were possible in furniture. That approach had worked in faucets, where a range of products could be made in the same factory, sold through the same channels, installed by the same plumber, and often bought by the same customer for use in different locations in a house. In furniture, however, manufacturing, distribution, retailing, and customers differ dramatically from the top end of the market to the bottom, making scope economies much more difficult to achieve. Discount furniture is mass-produced and massmarketed, while expensive furniture is largely handmade and distributed through specialty retail shops. Few customers buy furniture at both ends of the price and quality spectrum, and the products are almost never found at the same retailer. Similarly, scale economies were difficult to come by in furniture. Even after it purchased its way to market leadership, Masco held only a paltry 7 percent of the market, compared with its 30 percent in faucets. Seven percent was unlikely to confer much, if any, economic advantage, particularly when spread across so many styles, so many manufacturing plants, so many channels, and so many price points. Like other furniture manufacturers, Masco’s fortunes were hindered by the industry’s extreme product variety, high shipping costs, and cyclicality, which in combination make it extraordinarily difficult to manage a supply chain efficiently, or profitably substitute capital equipment for labor. Without a compelling way to address these issues, a manufacturer will always be at their mercy. Above all, Masco failed to learn the biggest lesson of its success in faucets. Its one-handle and washerless products gave it unique advantages that addressed important customer needs. Everything else it did in that industry flowed from those key differences. In a market where functionality was crucial, Masco had a demonstrable product edge. In furniture, an industry ruled more by fashion than function, Masco had no such core advantage, nothing that was strong enough to counter the gravitational pull of the industry’s unattractive competitive forces. Like those French generals, Masco failed to access its own battle readiness. It placed unwarranted faith in its superior management élan vital and underestimated the forces it was up against. One executive used a different but similar metaphor to describe what the company did: “Masco walked into a lion’s den and was unprepared to meet a lion.” THE STRATEGIST IN REMORSE Richard Manoogian, CEO-strategist and son of the company’s founder, took the outcome hard. At stake wasn’t merely a company he ran but the legacy his father had created and passed on to him. Father and son had strung together thirty-one years of consistently superior performance and created a superb reputation on Wall Street. All of that went up in smoke. In a story titled, “The Masco Fiasco,” Financial World observed: “The Masco Corp. was once one of America’s most admired companies; not anymore.” Though Manoogian promised to return the company to “its past glory,” he would have to regain the trust of his shareholders, many of whom felt “stuck in a nine-year nightmare of broken promises.”11 It was a case of the overconfident strategist. Along with many other companies that tried to crack the furniture industry, Masco believed a disorganized, competitive, low-profit business offered easy prospects for a disciplined, well-managed company. By some process of optimistic thinking, superficial analysis, and misplaced analogy, serious industry problems began to look like golden opportunities. The same hopeful thinking reappears every time I teach the Masco case. In their initial analysis of the furniture business, my students—all seasoned executives—duly note how unattractive it is. Yet when the time comes to decide what Masco should do, they prefer to interpret every problem as an opportunity (an “insurmountable opportunity,” as some wag once said). Chaos, cyclicality, fragmentation? Great! No dominant player and low brand recognition? Wonderful! A difficult-to-manage supply chain with large, expensive items, and huge variety? Terrific! Seemingly, there was nothing Masco’s resources and prowess could not overcome or turn to their advantage. It is the myth of the super-manager in full force. I suspect Masco fell into the same trap. In the face of deeply ingrained, long-lived industry problems, its leaders succumbed to a costly bout of irrational faith in the power of superior management. THE POWER OF REALISM Do the lessons of Masco resonate with you? More than twenty years after the Masco fiasco, my students repeatedly approach me to say, “My industry is just like the furniture business! I’m working really hard and getting nowhere.” For them it’s a eureka moment. The issues they’ve been battling suddenly come into focus, and they understand the larger reasons for their struggles. They, like Welch, Buffett, and other astute business leaders, grasp the lesson of the industry effect and its profound implications for firm performance. They recognize that, as in the famous serenity prayer, you must accept the things you cannot change, have the courage to change the things you can, and the wisdom to know the difference. It’s a lesson great strategists understand well, but it’s not an easy lesson to accept and master. The myth of the super-manager is hard to let go. The fundamental lessons here are simple but of paramount importance for the strategist. First, you must understand the competitive forces in your industry. How you respond to them is your strategy. That means if you don’t understand them, your strategy is based on luck and hope. Second, even if you understand your industry’s competitive forces, you must find a way to deal with them that is up to the challenge. That may mean skillful positioning, deliberate efforts to counter negative forces or exploit favorable ones, or even a timely exit. But don’t be trapped by the myth into believing that your superior management skills will carry you to success. Third, whatever you do, don’t underestimate the power of these forces. Their impact on the destiny of your business may well be as great as your own. The story you will write as a strategist will be set against the backdrop of your industry. It must be true to its realities, while having a difference that’s all its own. It’s to the second of these challenges that we now turn. Chapter 4 Begin with Purpose WE’VE LEARNED SOME painful lessons about the challenges that confront strategists in the face of unattractive industry forces. With this chapter, I begin mapping the path out of the wilderness: specifically, explaining how some astute strategists have managed to distinguish their businesses even in the face of such headwinds. The journey starts with an individual: Ingvar Kamprad, the founder of IKEA who by all accounts built one of the world’s greatest fortunes. Like Richard Manoogian of Masco, Kamprad was in the furniture business, but his story couldn’t be more different. In 2010, his privately held company, which he started in 1943 at the age of seventeen, had sales of 23.1 billion euro, net profits of 2.5 billion euro, and gross margins of 46 percent. And the numbers don’t even begin to capture IKEA’s powerful hold on consumers. As BusinessWeek put it, “Perhaps more than any other company in the world, IKEA has become a curator of people’s lifestyles, if not their lives. IKEA World [is] a state of mind that revolves around contemporary design, low prices, wacky promotions, and an enthusiasm that few institutions in or out of business can muster.”1 How did Kamprad succeed where Manoogian failed? He built his company by creating what I like to call a difference that matters. (The full meaning of this phrase will become clear as the story unfolds.) He did so, not by ignoring industry forces, as Manoogian did, but by creating a company that could thrive and add value in the midst of them. If you’re one of the millions who have shopped at IKEA, you’ll likely have indelible memories of vast, bright, modern stores designed so that entering customers follow a winding path through a huge building filled with furnishings and a great miscellany of housewares. When you chose a piece of furniture—a simple Micke desk for 69 euro, or a ten-person Norden dining table for 269 euro—you noted the information on an order slip, continued on the path to a warehouse-like room, wrestled a flat box containing the item onto your shopping trolley, carted it home on the rooftop of your car, and assembled it yourself. If you brought the kids, you may have parked them in the on-site child care center; you may also have stopped at the restaurant to sample tasty and inexpensive food ranging from salmon to Swedish meatballs and lingonberry tarts. It’s almost a theme park: probably not a customer experience you’d relish if you’ve made your fortune, but when you were starting out, there was nothing that could match it. RURAL ROOTS One could say that Ingvar Kamprad was a natural-born entrepreneur. “Trading was in my blood” he told his biographer, Bertil Torekull.2 Kamprad was about five when his aunt helped him buy a hundred boxes of matches from a store in Stockholm that he then sold individually at a profit in his rural hometown of Agunnaryd, deep in the farmland of Smaland. Soon he was selling all sorts of merchandise: Christmas cards, wall hangings, lingonberries (he picked them himself), fish (which he caught), and more. At eleven, he made enough money to buy a bicycle and typewriter. “From that time on,” he recounted, “selling things became something of an obsession.”3 Before going to the School of Commerce in Gothenburg, Kamprad signed the paperwork to start his own trading firm, IKEA Agunnaryd [I for Ingvar, K for Kamprad, E for the family farm Elmtaryd, and A for Agunnaryd]. The mail-order business grew to include everything from fountain pens and picture frames to watches and jewelry. With a keen eye for value, Kamprad ferreted out the lowest-cost sources. Frugality was the norm in Smaland. Its farmers, eking their living from a harsh and spare environment, had to make every penny count. Noticing that his toughest competitor in the catalog business sold furniture, Kamprad decided to add some to his offerings, supplied by small local furniture makers. Furniture quickly became the biggest part of his business; in the postwar boom, Swedes were buying a lot of it. In 1951, at age twenty-five, he dropped all his other products to focus exclusively on furniture. Almost immediately he found himself in a crisis. Growing competition from other mail-order firms led to a price war. Across the industry, quality dropped as merchants and manufacturers cut costs. Complaints started to mount. “The mail order trade was risking an increasingly bad reputation,” Kamprad said.4 He didn’t want to join the race to the bottom, but how could he persuade customers that his goods were sound when they had only catalog descriptions to rely on? His answer: create a showroom where customers could see the merchandise firsthand. In 1953 he opened one in an old two-story building. The furniture was on the ground floor; upstairs were free coffee and buns. Over a thousand people came to the village for the opening, and a gratifying number wrote out orders. By 1955, IKEA was sending out a half a million catalogs and had sales of 6 million krona. Kamprad understood his customers on a personal level. As he would later say, in explaining IKEA’s philosophy, “Since IKEA turns to the many people who as a rule have small resources, the company must be not just cheap, nor just cheaper—but very much cheaper . . . the goods must be such that ordinary people can easily and quickly identify the lowness of the price.”5 By following this philosophy, Kamprad became a force to contend with in the Swedish furniture industry—and, not liking his low prices, the industry struck back. Sweden’s National Association of Furniture Dealers began pressuring suppliers to boycott him and, with the support of the Stockholm Chamber of Commerce, banned him from trade fairs. Many of the suppliers stopped selling to him, and those that continued to do business with IKEA resorted to cloak-and-dagger maneuvers: sending goods to fictitious addresses, delivering in unmarked vans, and changing the design of products sold to IKEA so they wouldn’t be recognized. Soon Kamprad was suffering the humiliation of not being able to deliver on orders. He counterattacked on several fronts—for example, he began paying suppliers within ten days, as opposed to the standard industry practice of three or four months, and he started a flock of little companies to act as intermediaries. These moves helped, but IKEA was growing rapidly and supplies were short. Without a reliable source of supply, Kamprad feared his business would be doomed. Having heard that Poland’s communist government was hungry for economic development, Kamprad began scouring the Polish countryside. He found many eager and willing small manufacturers laboring in the shadow of the bureaucracy. Their plants were antiquated and the quality of their products was dreadful, so Kamprad located better-quality (though used) machinery in Sweden. He and his staff moved the machinery to Poland and installed it, working hand in hand with the manufacturers to raise productivity and quality. The furniture they turned out ended up costing about half as much as Swedishmade equivalents and Kamprad was able to nail down his costs on a huge new scale. Thus the boycott turned out to be what I call an “inciting incident,” to borrow a phrase from screenwriter Robert McKee—an event that propelled a critical strategic shift.6 “New problems created a dizzying chance,” Kamprad said. “When we were not allowed to buy the same furniture others were, we were forced to design our own, and that came to provide us with a style of our own, a design of our own. And from the necessity to secure our own deliveries, a chance arose that in its turn opened up a whole new world to us.”7 To Kamprad, it wasn’t enough to simply source in developing countries. He also brought extraordinary determination and imagination to his drive for lower costs. For example, he wasn’t afraid to draw on unconventional sources. He turned the job of making a particular table over to a ski manufacturer, who could deliver it at an especially low price. He bought headboards from a door factory, and wire-framed sofas and tables from a maker of shopping carts. IKEA was also a pioneer in building “board-on-frame furniture,” comprised of finished wood on a particleboard core, which is both cheaper and lighter than solid wood. Then, of course, there is the iconic IKEA packaging—the famous flat pack with its do-it-yourself assembly. While the company didn’t invent this approach, it was the first to grasp and systematically exploit its full potential. The flat pack provides huge cost savings by making shipping, distribution, and storage much more efficient and thus much cheaper. It saves manufacturing steps; it saves shipping costs from factory to store; it saves stocking and handling costs in the store; and it eliminates delivery costs for most customers. IKEA opened its first store in 1958 in Almhult. Five years later it opened one in Norway, and two years after that, a second Swedish store in Stockholm. It became a nascent global player with openings in Switzerland in 1973 and Germany in 1974. It entered the United States in 1985, China in 1998, Russia in 2000, and Japan in 2006. In 2010, IKEA had 280 stores in twenty-six countries, and served 626 million visitors.8 BEYOND LOW PRICES So how do you account for IKEA’s success in this terrible industry? Most likely your immediate thought is “low prices, low prices, low prices.” Indeed, IKEA’s prices are so low they’re not just a difference in degree from competitors’ but a difference in kind. Over the past decade, the company has lowered its prices by 2 to 3 percent a year on average. Every aspect of IKEA’s operation is subject to ongoing scrutiny to see where further costs can be taken out. Even flat packs have been repeatedly redesigned to gain small efficiencies in the use of space. Kamprad regarded the customary perks of business leadership as waste, too. Stories are legend of his flying coach class or taking a bus instead of a taxi or limousine. It’s an attitude that’s been adopted wholeheartedly by others in the company who speak of spending money unnecessarily as a “disease, a virus that eats away at otherwise healthy companies.”9 But IKEA is not a dollar store: Low prices don’t begin to tell the whole story. Scandinavian design was becoming popular around the world in the 1950s and it suited IKEA’s strategy perfectly. The simplicity of the clean lines made the furnishings particularly appealing; it also made them cheaper to produce than more ornate designs. Kamprad pushed this envelope farther, hiring first-class talent who could design for both style and for frugal manufacturing techniques. Perhaps IKEA’s greatest design achievement has been to make its furniture look and feel more expensive than it is. A turning point came in 1964 when a respected Swedish furniture magazine compared IKEA furniture with more highly regarded brands. IKEA’s, it found, was often as good or better. That shocked the industry and helped to persuade consumers that they had nothing to lose—either financially or in terms of status—by shopping at IKEA. Unlike so many discount retail stores, IKEA’s are anything but dark and dingy. The company’s vibrant colors (mostly blue and yellow, the colors of the Swedish flag) are everywhere, and except for the weekend crowds, the stores are pleasant places to visit. You can make a day of it: Come with the family, try out the sofas, use the computerized tools to design your own kitchen, and have a full-fledged Swedish meal at the restaurant. If, at the end of the day, you’ve bought too much to load onto your car, you can rent an IKEA van to drive it all home, or even pay to have things delivered, assembled, and set up. So, what is it that is special about IKEA? I ask you. Low price? Design? Flat pack? Swedish meatballs? What? The answer, of course, is “all of the above.” The centerpiece is low cost—without that, nothing else works—but everything else not only supports low cost but adds its own distinctive attraction. At this point, you, like many managers, may feel like, “Okay, we’re done—we’ve cracked the case. We know the answer, time to move on.” Maybe so. But what is the real lesson here? What do you take with you to apply to your company? That low cost with some added distinctive features is a winning combination? Often it is. But what if I tell you there is a deeper insight here, an insight that applies to all businesses whether you’ve decided to compete on low price or with differentiated, specialty products. It’s something else that was behind everything IKEA did. A CONCEPT COMPANY If Ingvard Kamprad were here and we asked him to describe the essence of what IKEA was doing, what would he say? His own words are instructive: “We are a concept company.” He goes on to describe the idea that guides the firm. IKEA offers “a wide range of well-designed, functional home furnishing products at prices so low that as many people as possible will be able to afford them.” This serves the company’s aim to create “a better everyday life for the many.”10 These words weren’t said by Kamprad on rare occasions. He said them often, over and over. He wrote them out, and more like them, in statements and booklets he printed and distributed to employees. All new employees are indoctrinated with these ideas, and they’re prominent in the company’s annual report today. Although IKEA calls this statement its “concept,” the word I prefer is purpose. Purpose is the way IKEA or any other company describes itself in the most fundamental terms possible—why it exists, the unique value it brings to the world, what sets it apart, and why and to whom it matters. Notice how IKEA’s purpose as expressed above answers all these questions. I suspect, though, that some of you, like some EOPers, are leery of lofty prose. Perhaps you consider Kamprad’s words mostly PR fluff—fancy words to dress up a hard-nosed, cost-cutting approach. But these words don’t just “dress up” low prices. On the contrary, they are what drive IKEA’s low prices and all the other features that make it stand out. To underline the point, consider something else Kamprad wrote in “A Furniture Dealer’s Testament,” a document he prepared to keep the growing company focused on what it was all about: We have decided once and for all to side with the many. . . . The many usually have limited financial resources. It is the many whom we aim to serve. The first rule is to maintain an extremely low level of prices. But they must be low prices with a meaning. We must not compromise either functionality or technical quality.11 So it wasn’t low prices alone that drove IKEA. Low prices weren’t the goal but rather a means to an end: “low prices with a meaning”—a better everyday life for the many. What was Masco’s purpose in furniture? It didn’t really have one, did it—other than a vague belief that it would have some sort of scale advantage and would bring professional management skills and capabilities to an industry that sorely lacked them. In contrast, IKEA’s clear and compelling purpose addressed a long-lived market need, created a distinctive niche, and mattered a lot to its customers. As you mull the idea of corporate purpose, you may make the connection to the more familiar “competitive advantage.” In fact, the terms purpose and competitive advantage could be used in conjunction with each other, but competitive advantage places the focus on a firm’s competition. That’s important, but it’s not enough. Leaders too often think the heart of strategy is beating the competition. Not so. Strategy is about serving an unmet need, doing something unique or uniquely well for some set of stakeholders. Beating the competition is critical, to be sure, but it’s the result of finding and filling that need, not the goal. Consider the power of purpose and the differences it spawns across firms. In the last chapter we looked at the average profitability of different industries as a whole. We treated each industry as if it were a single entity, and showed the average profitability of firms in each industry, the industry effect. Here we consider the variation in profitability within an industry, across players. This is the firm effect—the difference between an individual firm’s profitability and the average profitability in its industry. Positive or negative, large or small, it’s the sum of the impact of all a firm’s actions. Firm effects are directly tied to the work of a strategist, and over the long run are one of the best indicators of success or failure on the job. Within an industry, they can vary widely, even though most of the players work in a similar context and face largely the same competitive forces (See Exhibit 4-1, below). In tobacco, for example, Imperial Tobacco and Altria have returns that are even higher than the industry average, giving them positive firm effects. Reynolds American and others, in contrast, have negative firm effects. In airlines, Ryanair and Southwest buck the negative industry return while many of their competitors fare far, far worse. The chart on Furniture Retailing shows the net profit margin for a number of furniture retailers around the globe. Average profits in the industry are low (4.9 percent), but some firms do better than the average, and IKEA (whole returns are estimates) is at or near the top of the pack.12 The key question: What explains the firm effect that creates such differences among players in an industry? What can lead a company like IKEA to excel even in a business as tough as this? The answer, I believe, begins with purpose. Purpose is where performance differences start. Nothing else is more important to the survival and success of a firm than why it exists, and what otherwise unmet needs it intends to fill. It is the first and most important question a strategist must answer. Every concept of strategy that has entered the conversation of business managers—sustainable competitive advantage, positioning, differentiation, added value, even the firm effect—flows from purpose. EFFECTIVE PURPOSES All this sounds attractive to the leaders I’ve worked with. It seems to lift their work above the dog-eatdog world of cutthroat competition and harsh reality. Most of them want to feel that what they do matters in some context larger than themselves and larger even than their companies. They want to play their roles on as large a stage as possible. And so they embrace the idea of purpose because it feels inspiring. And, as we’ll see, that’s part of it. But to be a serious guide for a company, a purpose needs to do much more. A good purpose is ennobling. It makes a firm’s endeavors noble or more dignified. In addition to its other merits, a good purpose can satisfy this need. It is inspiring to all involved, to the employees pursuing it, to customers, and to others in your value chain. The people at IKEA don’t believe they’re flogging cheap furniture. They believe they’re creating “a better everyday life” for the many people who can’t afford top-end furnishings. In a Gallup poll nearly all respondents said it is “very important” or “fairly important” to them to “believe life is meaningful or has a purpose,” but less than half of the workers in any industry felt strongly connected to their organization’s purpose. Equally interesting, a number of people in less than life-and- death careers (for example, septic tank pumping, retail trades, chemical manufacturing) felt a strong connection to the goals of their organizations, while others in some traditional “helping” fields (for example, hospital workers) felt far less connection. An analysis of the work concluded: There is no such thing as an inherently meaningless job. There are conditions that make the seemingly most important roles trivial and conditions that make ostensibly awful work rewarding. . . . The least engaged group sees their work as simply a job: a necessary inconvenience and a way of earning money with which they can accomplish personal goals and enjoy themselves outside of work.13 Don’t overlook the role of purpose in fostering the care and commitment that lead people to produce good results. Consider a business forms company that sells its services to small businesses. You can’t get much more mundane than invoices and sales slips, but the people there said: “What we do isn’t glamorous, but it’s essential. When you can’t pay people or give the customer a receipt, the business stops running.” A good purpose puts a stake in the ground. It says “We do X, not Y.” “We will be this, not that.” It’s a commitment. Choosing to be one thing means not being something else. Michael Porter recognized that such choices involve trade-offs—letting some things go in order to be better at something else.14 Companies that don’t choose, for whatever reason, run the risk of ending up in no-man’s-land, being nothing of distinction to anyone. If your purpose does not preclude you from undertaking certain kinds of work, then it’s not a good purpose. Purpose, like strategy, is about choice, and a real choice contains, if only implicitly, both positive (“We do this”) and negative (“By implication, then, we don’t do something else”) elements. One executive I worked with in the EOP program, Pedro Guimaraes, a CEO of a small but growing movie production company, discovered this only after he clarified his purpose. His firm was primarily backed by an angel investor, a woman who had become very wealthy from her own business ventures and now, through this company, was pursuing a longtime personal love of movies and culture in general. As part of our work in the program, Pedro wrote out his purpose for the company, describing how it would make money through the production of advertising and movies that were commercial successes. When he showed the purpose to his investor, he discovered what had only been simmering under the surface of their relationship. He wanted to produce top-grossing box-office hits and make profits. She had little interest in those and instead, primarily wanted to produce art films, the kind once made by Ingmar Bergman in Sweden or Federico Fellini in Italy. At that moment he finally understood why the investor had balked at a number of projects he had proposed. From the outset they had been on different pages, but had never dug deeply enough into their respective purposes to see the incompatibility. They parted company amicably, and each went on to ventures that were more consistent with their different aims. A good purpose sets you apart; it makes you distinct. If you can only describe your business generically—“We’re a PR firm” or “We’re an IT consulting company”—then you don’t have a real purpose. Somehow the reason you exist, the specific customers you’ve chosen to serve, the market needs you fill, must set you apart from others who generically do what you do. Generically, IKEA is a furniture retailer, but that description doesn’t begin to say why it matters or what distinguishes it from others in the industry. Here is how IKEA describes its difference: From the beginning, IKEA has taken a different path. . . . It’s not difficult to manufacture expensive fine furniture. Just spend the money and let the customers pay. To manufacture beautiful, durable furniture at low prices is not so easy. It requires a different approach. Finding simple solutions, scrimping and saving in every direction. Except on ideas.15 Where do differences come from? They arise from innovation, new ideas, and deep insights about how things are and how they could be better in some consequential way. These can be anything from a new production technology that enhances efficiency, to new, different, and more appealing products, to a change in the way products or services are sold or delivered. Sometimes what matters is not just one innovation, but a cluster of innovations that flow from a new concept, a new way of doing business. This was the case for IKEA. Its greatest innovations were not in original furniture designs, or even in the technical invention of the flat pack, but in a new idea of how to go to market and how to provide a set of customers with products and a shopping experience that met their needs resoundingly well. IKEA’s experience illustrates a key advantage of a good purpose. A clear sense of what a company is striving to do can serve as a focal point or a core organizing principle around which a whole set of innovations and distinctive features can coalesce. Above all, a good purpose sets the stage for value creation and capture. Good economics are not the only reason your business exists, but without them, it’s unlikely that any of your other goals will be realized. Whatever your purpose, it must mean something to others in ways that produce good economic outcomes for you. What made IKEA’s purpose so powerful was not just that it was distinctive or welldefined, or that it made people feel part of something bigger and more important. It also drove IKEA’s superior performance in its industry. ADDING VALUE FOR EVERYONE The acid test, then, of a purpose is this: Will it give you a difference that matters in your industry? Not all differences are equal. You need a difference with real consequences. I often see companies claim differences that in fact are simply points of distinction without much consequence in their industries —“one-stop shopping,” “oldest continually operated,” “largest independent supplier.” Even a legitimate difference such as “best-in-class quality” is often rendered meaningless by companies that trumpet the words but don’t make the investments or tough trade-offs such a goal requires. IKEA’s purpose set it up to deal with the industry forces that scuttled Masco and many others in the furniture business. The company took two of the industry’s biggest problems—price competition and customers’ low willingness to pay—and made them a virtue through specific techniques such as lean manufacturing, the flat pack, and store design. It dealt with the industry’s costly practice of manufacturing a huge variety of furnishings by selling a limited selection of furniture pieces within one style. Many people think about strategy as a zero-sum game between a firm and its competitors, suppliers, and customers: How do we win? How do we get what’s best for us? In doing so, they largely focus on the sphere that’s closest to home: increasing their own profits—through higher prices or lower costs. On the Added Value chart, it’s the region called “Value captured by firm.”16 A trio of economists17 —Adam Brandenburger, Barry Nalebuff, and Harborne Stuart—who study game theory suggest a wider angle. They remind us that managers need to think not only about what’s best for their own firms, but also about how what they do affects others. This involves the two outer lines: Customers’ Willingness to Pay (essentially customers’ satisfaction with a good or service) and Suppliers’ Willingness to Supply (essentially their opportunity cost—the lowest price at which they would be willing to sell to a particular firm). It’s when a company drives a wider wedge between these lines— expanding the total value created—that its existence matters in an industry. When it does so, it is much more likely to be able to claim some of the value for itself—i.e., increase its own profitability—without making its partners in trade less well off. Wal-Mart is a classic example. It offers its customers good quality products at considerably lower prices, increasing the value customers capture from the relationship. At the same time, Wal-Mart lowers its own costs by lowering the costs of its suppliers. It does this by buying in scale, sharing information, and taking costs out of their systems. There are interesting parallels between Sam Walton and Ingvar Kamprad—for example, they both nurtured their vision of low-cost retailing in backwaters, where they learned how to court customers without much money. The most important parallel, though, from the standpoint of strategy, is that they both understood the benefits of adding value through one’s existence, not just fighting over who gets the biggest share of the pie. As it was growing into the company it has become, IKEA helped its suppliers save money. It designed furniture to be less expensive to manufacture. Its flat-pack approach eliminated significant shipping and assembly costs. It ordered in volume and provided data that made its suppliers more efficient. For suppliers, all of these drove down the costs of doing business with IKEA, and, in turn, reduced the price at which they were willing to sell to the firm. There’s still more to IKEA’s difference that matters. Through design and the distinctiveness of its approach, it created name recognition in a business not known for strong brands. It broke an ancient tradition of furniture as a long-term investment, and promoted the view of furniture as fashion. And it countered customers’ general reluctance to shop for furniture by providing free child care and low-priced restaurants with good food, both of which increased the length of time people spent in the store.18 So IKEA created value all around: Vendors could produce and sell for less, customers were pleased with the experience yet able to pay less, and IKEA was able to capture some of that value itself. Successful premium-priced players, like BMW or Disney, create value differently. Their goal is to provide uncommonly good products or services that command high prices and generate particularly high levels of customer satisfaction. To do so, they typically incur higher-than-average costs that are more than compensated for by increases in customers’ willingness to pay. For any firm, however, the logic is the same: You create value by driving the widest wedge you can between the satisfaction of your customers and the all-in costs of your suppliers.19 That means not only moving your own costs or prices relative to others in the industry, but moving one or both of those outer lines as well. Viable purposes, worthy of guiding everything else that happens in a company, must matter not only to you but also to those with whom you do business. Creating value for others is the surest way to capture some yourself. DOES YOUR BUSINESS MATTER? It’s not as easy as you might think to know whether your business has a viable purpose, or whether it truly adds value in your industry. Financial success at any given moment is an indication, but may prove fleeting. However, there is one simple question20 that—if you can answer it honestly—will give you a good idea. In essence, it’s the one I asked you at the start of this book: If your company disappeared today, would the world be different tomorrow? Despite our long discussions about purpose, and their general buy-in to the idea, this question always catches EOP executives by surprise. Frankly, it’s not a question most have been asked or asked themselves. It’s a real soul-searcher. But it’s one I hope you recognize that you need to answer. Here’s what it means to be different in a way that matters in your industry. It means that, if you disappear, there will be a hole in the world, a tear in the universe of those you serve, your customers. It means customers or suppliers won’t be able to go out and immediately find someone else to take your place. If you don’t have that difference, nobody will mourn you when you’re gone. And if they won’t miss you then, how much do they need you now? One more question: Whose job is it to find an answer, to make sure there’s an answer? It’s your job, the job of the strategist, the leader who’s responsible for the success and survival of the firm. It may not be the job of the strategist to invent a firm’s purpose on the lonely mountaintop and then come down and deliver it. Many people may be involved in its creation. But whether there is a purpose and whether that purpose is viable is a leader’s first responsibility. This is the strategist’s job. Are you a strategist? Chapter 5 Turn Purpose into Reality AS THE IKEA story demonstrates, defining a sound and distinctive purpose for your business is essential. It is a strategist’s way to stake a claim. With it, you have earned the right to play, to take part in the game. But winning the game? That takes more. Consider the experience of Domenico De Sole, an Italian-born, Harvard-trained tax attorney who in 1994-95 was thrust into the top job at Gucci.1 Though he had previously led the company’s North American operations, he was stunned by what he discovered when he saw the entirety of the onceadmired company. Sales were plummeting, customers were indifferent, and red ink was flowing. Internally, Gucci had reached a state of paralysis: Management was balkanized and people were scared to make important decisions, even about such basic issues as guaranteeing a supply of bamboo handles for Gucci’s signature handbag. “There was no merchandise, no ...
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