by Emily Chan
If it is a strategic acquisition, the buyer may be willing to pay a price higher than what would be paid by the public.
If acquired by a private company or a company of much bigger size, then there is less risk of needing to disclose sensitive information.
Hence, IPO is not the only financial goal for start-ups and smaller companies. In fact, one of the highest profile start-ups in recent HBS history is Eachnet. Its organizers’ plan from day one was to copy eBay’s model for China. However, since China does not have a developed credit card system and the consumer sophistication found in the West, it was difficult for the company to have an efficient way to charge users and make money. But that was not an issue as the plan was never about making money from consumers. Of course, without a plan to actually make money, an IPO was not even an option. The key target was to sell to eBay. Eachnet’s founders bet on the expectation that eBay would find it an invaluable jump-start for the China market and eBay would have so much cash and tradable stocks from its U.S. IPO that it could acquire Eachnet at a very high price. Many investors considered it a very risky strategy and did not invest in Eachnet. But for the few who did, it paid off; they managed to make a significant amount of money when Eachnet was eventually sold to eBay.
Notes
1. Sundem Homgren and Elliot Prentice Hall, Introduction to Financial Accounting (Upper Saddle River, N.J.: Prentice Hall, 1998), 494.
2. Robert Knox and James Inkster, “Postdecision Dissonance at Post Time,” Journal of Personality and Social Psychology 8 (1968): 319–323.
3. Hal Arkes and Catherine Blumer, “The Psychology of Sunk Cost,” Organizational Behavior and Human Decision Process 35 (1985): 124–140; and Hal Arkes and Laura Hutzel, “The Role of Probability of Success Estimates in the Sunk Cost Effect,” Journal of Behavioural Decision Making 13(3) (2000): 295–306.
4. John S. Hammond, Ralph L. Keeney, and Howard Raiffa, “The Hidden Traps in Decision Making,” in Harvard Business Review on Decision Making (Boston: Harvard Business School Press, 2001), 153.
PART III
STRATEGY
11
THE BIG PICTURE
WHAT IS STRATEGY?
Strategy is a sexy word: it is the crown jewel of business concepts, and everyone wants to use it. As the rather trite saying goes, “What good is doing things right (efficiency, execution, operations, and so on) if you are not doing the right things (strategy).” Strategy conjures up an image of big guys looking at the big picture for the long-term. It is a major compliment at HBS and anywhere in business to be seen or described as a “strategic” thinker.
Strategy is also a promiscuous concept. By this, I mean it has so many different definitions that you can call almost any plan “a strategy.” Some examples of the various definitions of the concept of strategy:
Strategy can be a feature of different organizational levels, such as corporate strategy, business strategy, functional strategy, and so on. Some of these levels have overlapping definitions and add to the confusion; for example, mission can be part of corporate strategy or business strategy.
Strategy can be about different levels of detail. As author Paul Niven explains, “Some believe strategy is represented by the high-level plans. . . . Others would argue that strategy rests on the specific and detailed actions.”1
Strategy can be defined around different types of focus, such as a coherent, unifying, an integrative pattern of decisions, an allocation of limited resources, or an establishment of a long-term organizational purpose.
These are just a few examples of the wide range of possible definitions of strategy. Each definition is important and valuable because it explains a way of looking and thinking about strategy. Much insightful research has been done and hundreds of books have been written on each of the definitions.
While it would be a stimulating intellectual exercise to go through the whole list of definitions, for the purpose of this book, I focus on one simple yet effective choice. Based on HBS learning, my work experience as a strategy consultant, and the messages I have received from readers of my first book, it seems the most appropriate definition for our purpose is to see business strategy (or a strategy plan, a term I use interchangeably) as answering two key questions:
Is this business attractive?
How do I need to proceed if I mean to win?
To the frustration of a trained engineer like me, answering these two questions is very much an art, not a hard science. It takes judgment, experience, courage, and creativity rather than formulas and checklists. This is because the future is never certain. Strategy is about the future and the future of any market cannot be nailed down. Government policy, economic factors, customer preferences, and competitive landscape are just a few items on an unfathomable list of factors that can never be accurately predicted, even by the most powerful computers and the most experienced strategists.
In addition, the past and present are never perfectly documented. Even if the most powerful computers could be applied to the problem, they would not be able to function effectively without data; as the saying goes: “garbage in, garbage out.” However, some element of garbage is unavoidable: the truth involves some confidential information (such as competitive cost structure and competitive market shares); some information that does not exist in any readily available form (such as the impact of economies of scale on cost); some fragments (statistics available for some segments of the market but not others); some that is dated by the time it is published (such as the significant lag time for most government statistics), and so on. Hence, even with computers more powerful than any in existence, you probably would not be able to collect and input enough accurate data to generate the perfect scientific answer.
To make matters worse, situations are seldom if ever identical. So, even the most experienced strategists would not be able to produce an exhaustive checklist of standard, cookie-cutter strategies. No one can give you a menu listing the best way to deal with any business situation, without adaptation.
Luckily for someone like me, strategy is no longer a pure art. In the last few decades, academics, strategy consultants, and business leaders have made much progress in developing tools and best practices that can help bring a significant degree of analytical rigor into strategy and make it into somewhat of a “scientific art” rather than a “pure art.” These tools and best practices are very much the focus at HBS:
Frameworks
Data management
Classic strategies
Process
Frameworks
Frameworks provide effective levers to guide the planning process. Frameworks are structures that delineate the major relevant factors to be considered and the relationship between these factors. Top down–bottom up and supply-and-demand are examples of simple frameworks, as sketched in Figure 11.1.
You have two key choices for frameworks:
Figure 11.1 Simple Frameworks
You can adopt a classic framework developed by academics or strategy experts. These frameworks are powerful as they are distilled from years of research and analytical thinking. This is often a good starting point for people new to strategy planning.
In the section below, I discuss the three most well-known and widely used ready-made classic frameworks developed by HBS professors and taught at HBS:
Porter Five Forces (To answer the question, “Is this an attractive industry?”)
Porter Generic Strategies and Porter Value Chain (To answer the question, “How to achieve sustainable competitive advantages in an industry?”)
Balanced Scorecard (To answer the question, “How to monitor execution?”)
Alternatively, you can develop your own framework (I call it DIY—do-it-yourself). As you accumulate more experience in strategy or come to feel that existing frameworks do not fit your needs, you will want to develop your own frameworks. This will usually involve starting from some very basic frameworks (some people call it the skeleton) and then adding details (some peopl
e call this fleshing out the skeleton). Top down–bottom up and supply-and-demand are examples of skeletons. Later in this chapter, I present an effective DIY skeleton framework called The Tree. Once a framework is designed, the planning process should systematically analyze each factor of the framework and then synthesize the information into strategic options.
Data Management
Although past and present data will never be perfect, the strategy should still be based on the best data available. Frameworks list only the key factors and issues. Data is needed to analyze the factors and issues. Consultants who make their living doing strategies have developed key best practices and tools for gathering what is available, estimating what is unavailable, checking validity of all the data, and utilizing the data.
Classic Strategies
Even though it is impossible to develop an exhaustive checklist of standard strategies that one can pick and choose to apply to different situations, over the years, some reasonably reliable strategies have emerged. These strategies are useful as references and benchmarks to stimulate brainstorming. They are also useful for defense, as they make good starting points for assessing your competitors’ strategy.
Process
An effective planning process can, to a large degree, help manage future uncertainties. The importance of a planning process is succinctly explained by Dwight D. Eisenhower, the 34th president of the United States, when he talked about war:2
Plans are nothing; planning is everything.
Because of the uncertainty involved in war (and business), although it may be a bit extreme to say “plans are nothing,” there is much truth in President Eisenhower’s statement. This does not mean you do not need a strategy. You need a strategy—but must recognize that any strategy can easily and quickly become suboptimal or even ineffective due to the uncertainties involved. As a result, it is critical to know that the process of thinking through and developing the strategy is as important as the plan itself, if not more important. An effective process should be:
Systematically exhaustive. The process should ensure that key factors are prioritized, considered, and analyzed.
Explicitly articulated. The process should also ensure that the factors considered, any assumptions made about them, and the deductive logic behind the strategy are clearly and explicitly articulated and documented. Then when these factors and assumptions change, the strategy can be updated quickly and effectively to address the changes.
Execution oriented. A 1999 Fortune magazine research article showed 70 percent of chief executive officer failures were a result of poor execution, not poor strategy. Ever since then, business schools and the business community have realized the importance of not just planning the plan but also planning the execution of the plan.
PORTER FIVE FORCES FRAMEWORK
Is this an attractive industry? This is a million-dollar question for everyone in business—established enterprises need to evaluate their own industry or portfolio of industries as well as possible expansion into other industries; entrepreneurs and investment funds need to assess new markets, and individuals may come across opportunities to invest in private companies.
One of the most well-known and widely adopted frameworks for assessing the attractiveness of an industry is the Porter Five Forces. The framework was conceived by Professor Michael Porter of HBS, one of the world’s leading authorities on competitive strategy. This famous framework is taught, discussed, and used not only at HBS but also at many schools and in industry. The simplest version of it is set out in Figure 11.2.
The resultant of the strengths and weaknesses of these five forces will determine if an industry is attractive. At one extreme, if you’re looking at a situation where buyers and suppliers have little bargaining power, existing competitors are weak, and the threat from substitutes and new entrants is minimal, then it is most likely a highly attractive industry. The classic example of this is some of the utility monopolies. At the other extreme, if buyers and sellers have strong bargaining power, existing competitors are fierce, and the threat from substitutes and new entrants is significant, then the industry is most likely unattractive. Mom-and-pop stores often fall into this category. Often, the only reason a mom-and-pop store is surviving is that its owners do not draw market-level salary and are satisfied with a low return on capital.
Figure 11.2 The Five Competitive Forces that Determine Industry Profitability
Source: Michael E. Porter, Competitive Advantage—Creating and Sustaining Superior Performance (New York: Free Press, 1985), 5.
The framework as depicted in Figure 11.2 is simple and elegant. However, to be able to apply the framework effectively, you need to ask how you can tell if suppliers have strong or weak bargaining power. How can you tell if the barrier to entry is high? And so on. To assess the strength of each of the five forces, Professor Porter has developed a comprehensive list of drivers for each of them. By evaluating these drivers, a judgment can be made on the strength of each force. Table 11.1 lists some of the key drivers that I have found most useful in analyzing industry attractiveness.
Of course, some of these drivers, such as industry growth rate, will change over time, so the impact of the change on industry attractiveness must be monitored.
Table 11.1 gives only a partial list. Professor Porter’s list is almost exhaustive. It is very useful as a checklist, especially for novices who fear they might forget to consider some key drivers. However, the full list can seem daunting. I was overwhelmed when I first saw it many years ago. But after some practice, you will soon realize that the principle of prioritization, as discussed earlier, definitely applies. As Professor Porter explains, “In a particular industry, not all of the five forces will be equally important and the particular structural factors (or drivers) that are important will differ.”3
High priority should be placed on analyzing the drivers that can affect the business models. Business model can mean “how the business is going to make money,” “how the company is going to capture the value it creates,” or “who is going to pay for the product or service.” Business models include the subscription model, advertising model, commission model, mark-up model, and others. This concept is especially important in businesses involving high technology or new inventions, which have no established or proven business model. Many entrepreneurs at the height of the Internet bubble created value-added businesses that attracted millions of users but failed to find a way to make money from the business (no business model). Some of them were lucky enough to be acquired by bigger businesses that could add them to their core business to make money. But most of them simply failed when investor money ran out. Often, the critical drivers that need most in-depth analysis become apparent soon after some initial research is done.
Table 11.1 Industry Forces and Drivers
PORTER GENERIC STRATEGIES AND PORTER VALUE CHAIN
How do I need to proceed if I mean to win? When it comes to addressing this question, Professor Porter’s generic strategy framework is actually frighteningly simple yet most valid. He explains that although there seem to be endless ways a firm can try to compete and many different strengths and weaknesses companies can have versus their competitors, there are fundamentally only two ways to compete successfully—low cost or differentiation, as outlined in Table 11.2.
The two strategies, of low cost and differentiation, can be applied to the broad total market or to a certain segment within the market. The segmented versions are referred to as focus-low-cost or focus-differentiation strategies.
Porter calls low cost, differentiation, and focus (focus-low-cost or focus-differentiation) the three generic strategies. I find the Generic Strategy Framework effective not only as a guide for how to compete, but also as a reminder of how not to compete. If your strategy cannot be categorized into one of the three generic strategies, you risk having no real competitive advantage. Your offering is neither lower in cost than your competitors’ offering nor differentiated from it. Why should custo
mers buy from you? Unless you have a protected position (such as a monopoly or government license) or you have very weak competitors, you will be unlikely to compete successfully in the industry.
Table 11.2 Generic Strategies
Figure 11.3 Value Chain Framework
Source: Adapted from Michael E. Porter, Competitive Advantage-Performance (New York: Free Press, 1985), 37.
To decide on which generic strategy to adopt and settle on the details (where to save cost and how to differentiate), Porter has developed the value chain framework illustrated in Figure 11.3.
The framework is not rocket science—it is a basic tool to help systematically break down all the key activities a firm performs to be in business. Examining how each of these activities can be done and what impact each has on differentiation and cost makes it possible to see where competitive advantages can come from and which strategy should be adopted to win. For example, say you found out from Porter’s Five Forces that a chain supermarket is an attractive business in the city where you live. You then use the value chain to analyze how you could compete if you were to enter. If you find that your strengths would be in efficient procurement, logistics, and operations, then you would probably decide on a low-cost strategy. If you find that your strengths would be in procurement of exotic products and provision of high-end service, you would probably decide on a differentiation strategy. I find the framework a very useful starting point. Primary and supporting activities can be eliminated or added to fit the industry and business for the specific analysis.