Laws of Business Strategy
This article is part of a series on what causes a firm’s value to increase and is Part 2
In Part 1 of this article, we discussed the first three laws of business strategy:
1. Your Industry “Nature” Determines the Average Profitability for All Competitors in Your Industry
2. Prices and Costs Always Decline
3. Dominate Something, Do Not Be Spread Too Thin
If you missed Part 1 and would like to read it, please just email me below.
In this article I will discuss what I and other strategists think are the second three candidates for the laws of business strategy:
Strategy Law #4: Complexity Is a Killer
Does your sales force (I am not picking on them) almost always say “If we just offered this version of our product, or if we added more “bells and whistles”, more customers would buy it? Operations and production folks usually hate to hear this because they know it almost always increases the firm’s costs. If you add up the number of these kinds of “bolt ons” over say ten years, you could end up with a serious complexity problem. What is the problem? Figure 1 shows complexity affects both costs and revenues negatively.
Implications: Add complexity only if it can be tied to a key enhancement for current customers or allows you to attract new profitable customers. Toyota paid dearly for ignoring Law #4 until it reversed and heeded it.
Strategy Law #5: Competitive Position Determines Your Options
When your firm is faced with a strategic crossroad, that is, where you could take one road over another but not both, how do you decide which way to go? Law #5 says your successful moves are largely dependent on how big and how profitable you currently are. If you are the 500 pound gorilla like Wal-Mart, where its size ($460 billion is sales in 2011) and current Return on Invested Capital (14.9%) make them a leader, Law #5 says the 500 pound gorilla must “stay its current course aggressively”. It should not venture into unrelated kinds of businesses for your next round of growth. If you are a small niche player who is very profitable, you must invest to maintain your favored niche but must grow without lowering prices! If you are small and not profitable, Law #5 says “up or out very quickly” – do not pause to ponder too long. Implications: If you totally ignore your current competitive position, and decide to become something you are not, very boldly and very quickly, you will most times blunder, and sometimes horribly. Just ask Husky Injection Molding Systems of Canada.
Strategy Law #6: Customers and Profit Pools Do Not Stand Still
Starbucks radically changed the retail coffee part of the overall coffee industry. From coffee bean suppliers to exporters to processors of beans to retailers to machined commercial brewing, all saw shifting market shares and profits from 1995 to 2005. Law #6 says that the most profitable and high growth segments in an industry will change, and likely change at least every five to ten years. Firms who continue to be profitable high growth companies do six things particularly well according to Law #6:
Identify the most attractive target segments (potential for growth profits) and their needs faster and better than competitors
Design the best value proposition for them (what they get for the price)
Acquire more of the target customers
Deliver a superior customer experience
Grow “share of wallet” – what else can we offer these customers to win more of the discretionary dollars?
Drive loyalty and retention of those customers
Thereby being able to do #1 much more easily in a self-reinforcing cycle
Implications: it is cliché to say the “change is the only constant”. But I do not know of a better cliché. These seven attributes help overcome being left behind by the negative effects of Law #6.
You will notice Laws 1 through 5 are interconnected. Hostile industries (Law #1) cause faster Cost and Price reductions (Law #2) and the way out is to Dominate Something (Law #3) to break a usual downward cash flow spiral. But Law #4 says be careful in your Domination efforts that you do not get overly complex with too many varieties of offerings. Law #5 says you cannot think your firm is super human and become something it is not quickly. Law #6 is different from the first five. If you have been successful in following the first five laws, Law #6 can be a wakeup call. You can get complacent with your current customer group, only to see those customers and profit pools shifting to a bold competitor or new entrant.
If your industry is immune to one or more of the six laws for now, this is great. But the nature of a law says beware – they probably will come into play and these six laws should be discussed in every strategy session your organization has.
Next Up: Case Study: The Fall and Rise of Gucci