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Beating the Odds in the Strategy Room

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Several times a year, top management teams enter the strategy room with lofty goals and the best of intentions: they hope to assess their situation and prospects honestly, and mount a decisive, coordinated response toward a common ambition.

Then reality intrudes. By the time they get to the strategy room, they find it is already crowded with egos and competing agendas. Jobs—even careers—are on the line, so caution reigns. The budget process intervenes, too. You may be discussing a five-year strategy, but everyone knows that what really matters is the first-year budget.

So, many managers try to secure resources for the coming year while deferring other tough choices as far as possible into the future. One outcome of these dynamics is the hockey-stick projection, confidently showing future success after the all-too-familiar dip in next year’s budget. If we had to choose an emblem for strategic planning, this would be it.

In recent times, there are strategies set up out to help companies unlock the big moves needed to beat the odds. Another strategy framework? No, there are already plenty of those. Rather, the need to address the real problem: the “social side of strategy,” arising from corporate politics, individual incentives, and human biases. How? With evidence.

The social side of strategy

Nobel laureate Daniel Kahneman described in his book Thinking, Fast and Slow the “inside view” that often emerges when we focus only on the case at hand. This view leads people to extrapolate from their own experiences and data, even when they are attempting something they’ve never done before. The inside view also is vulnerable to contamination by overconfidence and other cognitive biases, as well as by internal politics.

It’s well known by now that people are prone to a wide range of biases such as anchoring, loss aversion, confirmation bias, and attribution error. While these unintentional mental shortcuts help us filter information in our daily lives, they distort the outcomes when we are forced to make big, consequential decisions infrequently and under high uncertainty—exactly the types of decisions we confront in the strategy room.

When you bring together people with shared experiences and goals, they wind up telling themselves stories, generally favorable ones. A study found, for instance, that 80 percent of executives believe their product stands out against the competition—but only 8 percent of customers agree.

Then, add agency problems, and the strategy process creates a veritable petri dish for all sorts of dysfunctions to grow. Presenters seeking to get that all-important “yes” to their plans may define market share so it excludes geographies or segments where their business units are weak, or attribute weak performance to one-off events such as weather, restructuring efforts, or a regulatory change.

Executives argue for a large resource allotment in the full knowledge that they will get negotiated down to half of that. Egos, careers, bonuses, and status in the organization all depend to a large extent on how convincingly people present their strategies and the prospects of their business.

That’s why people often “sandbag” to avoid risky moves and make triple sure they can hit their targets. Or they play the short game, focusing on performance in the next couple of years in the knowledge that they likely won’t be running their division afterward. Emblematic of these strategy-room dynamics is the hockey-stick presentation. Hockey sticks recur with alarming frequency, as the experience of a multinational company, whose disguised results appear in Exhibit 1, demonstrates.

The company planned for a breakout in 2011, only to achieve flat results. Undeterred, the team drew another hockey stick for 2012, then 2013, then 2014, then 2015, even as actual results stayed roughly flat, then trailed off.

EXH 1

To move beyond hockey sticks and the social forces that cause them, the CEO and the board need an objective, external benchmark.

The odds of strategy

The starting point for developing such a benchmark is embracing the fact that business strategy, at its heart, is about beating the market; that is, defying the power of “perfect” markets to push economic surplus to zero. Economic profit—the total profit after the cost of capital is subtracted—measures the success of that defiance by showing what is left after the forces of competition have played out.

From 2010 to 2014, the average company in our database of the world’s 2,393 largest corporations reported $920 million in annual operating profit. To make this profit, they used $9,300 million of invested capital, which earned a return of 9.9 percent. After investors and lenders took 8 percent to compensate for use of their funds, that left $180 million in economic profit.

Plotting each company’s average economic profit demonstrates a power law—the tails of the curve rise and fall at exponential rates, with long flatlands in the middle (Exhibit 2). The power curve reveals a number of important insights:

EXH 2

  • Market forces are pretty efficient. The average company in our sample generates returns that exceed the cost of capital by almost two percentage points, but the market is chipping away at those profits. That brutal competition is why you struggle just to stay in place. For companies in the middle of the power curve, the market takes a heavy toll. Companies in those three quintiles delivered economic profits averaging just $47 million a year.
  • The curve is extremely steep at the bookends. Companies in the top quintile capture nearly 90 percent of the economic profit created, averaging $1.4 billion annually. In fact, those in the top quintile average some 30 times as much economic profit as those in the middle three quintiles, while the bottom 20 percent suffer deep economic losses. That unevenness exists within the top quintile, too. The top 2 percent together earn about as much as the next 8 percent combined. At the other end of the curve, the undersea canyon of negative economic profit is deep—though not quite as deep as the mountain is high.
  • The curve is getting steeper. Back in 2000–04, companies in the top quintile captured a collective $186 billion in economic profit. Fast forward a decade and the top quintile earned $684 billion. A similar pattern emerges in the bottom quintile. Since investors seek out companies that offer market-beating returns, capital tends to flow to the top, no matter the geographic or industry boundaries. Companies that started in the top quintile ten years earlier soaked up 50 cents of every dollar of new capital in the decade up to 2014.
  • Size isn’t everything, but it isn’t nothing, either. Economic profit reflects the strength of a strategy based not only on the power of its economic formula (measured by the spread of its returns over its cost of capital) but also on how scalable that formula is (measured by how much invested capital it could deploy). Compare Walmart, with a moderate 12 percent return on capital but a whopping $136 billion of invested capital, with Starbucks, which has a huge 50 percent return on capital but is limited by being in a much less scalable category, deploying only $2.6 billion of invested capital. They both generated enormous value, but the difference in economic profit is substantial: $5.3 billion for Walmart versus $1.1 billion for Starbucks.
  • Industry matters, a lot. Our analysis shows that about 50 percent of your position on the curve is driven by your industry—highlighting just how critical the “where to play” choice is in strategy. Industry performance also follows a power curve, with the same hanging tail and high leading peak. There are 12 tobacco companies in our research, and 9 are in the top quintile. Yet there are 20 paper companies, and none is in the top quintile. The role of industry in a company’s position on the power curve is so substantial that it’s better to be an average company in a great industry than a great company in an average industry.
  • Mobility is possible—but rare. Here is a number that’s worth mulling: the odds of a company moving from the middle quintiles of the power curve to the top quintile over a ten-year period are 8 percent (Exhibit 3). That means just 1 in 12 companies makes such a leap. These odds are sobering, but they also encourage you to set a high bar: Is your strategy better than the 92 percent of other strategies?

EXH 3

The power of big moves

So what can you do to improve the odds that your company will move up the power curve? The answer is lurking in our data. Consider this analogy: To estimate a person’s income, we can start with the global average, or about $15,000 per year. If we know that the person is American, our estimate jumps to the average US per capita income, or $56,000. If we know that the individual is a 55-year-old male, the estimate jumps to $64,500. If that guy works in the IT industry, it jumps to $86,000. And if we know the person is Bill Gates, well, it’s a lot more than that.

Adding ever more information similarly helps to zero in on the probabilities of corporate success. Even if you know your overall odds, you need to understand which of your attributes and actions can best help you raise them. We identified ten performance levers and, importantly, how strongly you have to pull them to make a real difference in your strategy’s success. These levers were divided into three categories: endowment, trends, and moves. Your endowment is what you start with, and the variables that matter most are your revenue (size), debt level (leverage), and past investment in R&D (innovation). Trends are the winds that are pushing you along, hitting you in the face, or buffeting you from the side. The key variables there are your industry trend and your exposure to growth geographies. In analyzing the odds of moving on the power curve, we found that endowment determines about 30 percent and trends another 25 percent.

The moves that matter

However, it is your moves—what you do with your endowment and how you respond to trends—that make the biggest difference. Research reveals that the following five moves, if pursued persistently, can get you to where you want to go:

  • Programmatic M&A. You need a steady stream of deals every year, each amounting to no more than 30 percent of your market cap but adding over ten years to at least 30 percent of your market cap.
  • Dynamic reallocation of resources. Winning companies reallocate capital expenditures at a healthy clip, feeding the units that could produce a major move up the power curve while starving those unlikely to surge. The threshold here is reallocating at least 50 percent of capital expenditure among business units over a decade.
  • Strong capital expenditure. You meet the bar on this lever if you are among the top 20 percent in your industry in your ratio of capital spending to sales. That typically means spending 1.7 times the industry median.
  • Strength of productivity program. This means improving productivity at a rate sufficient to put you at least in the top 30 percent of your industry.
  • Improvements in differentiation. For business-model innovation and pricing advantages to raise your chances of moving up the power curve, your gross margin needs to reach the top 30 percent in your industry.

Greater than the sum of the parts

Big moves are most effective when done in combination—and the worse your endowment or trends, the more moves you need to make. For companies in the middle quintiles, pulling one or two of the five levers more than doubles their odds of rising into the top quintile, from 8 percent to 17 percent. Three big moves boost these odds to 47 percent.

Patterns of movement

You should be mindful of several dynamics when undertaking major strategic moves. First, research shows that really big moves can “cancel out” the impact of a poor inheritance. Making strong moves with a poor inheritance is about as valuable as making poor moves with a strong inheritance.

And even small improvements in odds have a dramatic impact on the expected payoff, owing to the extremely steep rise of the power curve. For example, the probability-weighted expected value of a middle-tier company increasing its odds to 27 percent from the average of 8 percent is $123 million—nearly three times the total average economic profit for mid-tier companies.

Big moves are also nonlinear, meaning that just pulling a lever does not help; you need to pull it hard enough to make a difference. For instance, productivity improvements that are roughly in line with the improvement rates of your industry won’t provide an upward boost. Even if you are improving on all five measures, what matters is how you stack up against your competitors.

And four of the five big moves are asymmetric. In other words, the upside opportunity far outweighs the downside risk. While M&A is often touted as high risk, for example, in reality programmatic M&A not only increases your odds of moving up the curve but simultaneously decreases your odds of sliding down. Capital expenditures is the one exception. By increasing capital expenditures, your chances of going up on the power curve increase, but so do the chances of dropping.

In general, making no bold moves is probably the most dangerous strategy of all. You not only risk stagnation on the power curve but also miss out on the additional reward of growth capital, which mostly flows to the winners.

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Growth-leadership mind-set needed to capture growth

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Everyone may be born a winner, but only few (if not none) are born leaders. Hence Leadership, like cooking, painting or any other skill must be developed and enhanced to the fullest potential. While growth is needed, the will to grow which first develops in the mind, takes precedence. Mind-set, curiosity, and a willingness to adapt to client needs and industry trends form the three core capabilities needed to succeed in any given business environment. A good business leader then, is mandated to harness these core capabilities to transform the business to higher heights; leadership delivered with a growth mind-set will absolutely birth the full potential of the business.

Growth-leadership mind-set offers a vast room for a leader to try so many strategies aimed at growing the business. There is room to try, fail, learn from it and do a better job and this, by extension gives the leader the ability to move at a steady pace yielding faster and better results on projects.

Having the growth-leadership mind-set is really critical. The end product presented to a client or customer reflects the kind of work flow and leadership present in the business, how teams/employees behave, how they act, collaborate, what they take to clients and even how they deal with failure shows in the final product that goes in front of the client. This is a feat consistent with leadership that is growth oriented. A leader whose sole focus is growth; A lack of these elements, a loss of clients/customers.

With a growth-leadership mindset, a business lead is driven Everyone may be born a winner, but only few (if not none) are born leaders. Hence Leadership, like cooking, painting or any other skill must be developed and enhanced to the fullest potential. While growth is needed, the will to grow which first develops in the mind, takes precedence.

Mind-set, curiosity, and a willingness to adapt to client needs and industry trends form the three core capabilities needed to succeed in any given business environment. A good business leader then, is mandated to harness these core capabilities to transform the business to higher heights; leadership delivered with a growth mind-set will absolutely birth the full potential of the business. Insights Insights to focus solely on making sure the business grows; trying new strategies that can move the business and not just limiting one to accepting what works and sticking to it.

Here growth is the focus and things must move forward in that direction, there is no room for stagnation. Thinking about how things can happen rather than thinking about how things cannot be changed. In other words; this mind-set allows a leader to step out of the business’s comfort zone and make impact while overcoming obstacles. That is the kind of leadership mind-set people in top positions must adopt in the various business settings.

It begins in the mind

Capita Chief Growth Officer, Ismail Amla, in an interview with McKinsey’s Biljana Cvetanovsk mentioned that when he was growing up, his dad used to tell him, “If you think you’re going to do it, you’re going to be right. If you think you’re not going to do it, you’re going to be right.” A growth-leadership mindset, for him, therefore, is the neuroscience confirming the hypothesis that how one thinks determines how they feel and how they behave, and how one behaves determines the outcome.

If the mind’s eye does not see growth and the prospects thereof, it will not happen. The team lead’s responsibility then becomes to see the growth ahead, map out a strategy to achieve that goal and drive the team to collectively hit the mark and scale higher. Else, the business may do well with what it knows to do and remain stagnant like it knows to be, but never higher than it could be.

Curiosity

A team lead needs to really understand what clients/ customers want. This has been termed in the market as “consultative selling” where the focus is on value and trust and exploring the client’s needs before offering a solution. This definitely gets one to understand the better what really people want or need.

Learning agility

It is not enough just knowing about something; a team lead has to go the extra mile to learn everything. It is important to learn what the problems are and how to solve them. Limiting oneself to just working by what you already know can only lead to failure. In addition to being curious and having a ready to learn attitude, a team lead should ultimately have a growth mind-set.

These are three core capabilities required to drive growth. People may sometimes attribute doing what they want to do at any time as a leader as growthleadership, but that is not the case; to get up, doing what needs to be done and adding the importance of time to task is what growth-leadership is. This leads to the next point, Take Action!

Take Action; do!

Further from the mind, the leader must then, walk the talk. Like the age old adage goes, talk is cheap. The strategies put on paper or mentioned orally must be fully executed to bring to full fruition what has been in mind. This is what will actually make the business growth happen.

Steps like delivering the best, meeting customer/client demands on time, maintaining consistency in delivery, making upward adjustments in the quality of work based on market demands and keeping a great client-agency relationship charts the business on the growth path. Taking all these steps, moving high mountains and deeper valleys to realize all the goals in the growth plan leads to the ultimate realisation of an elevation in the business structure, process and yield. A dive in the doing waters takes one beyond the mind to the actions of primarily the head.

The team lead with the growthleadership mind-set must first begin with improving on himself or herself and his/ her innate leadership qualities. Managers who show great leadership qualities can inspire their teams to accomplish amazing things. The other arm of the branch is the team. Accomplishing pragmatic coups also relies heavily on the efforts of a team; a team sharing the leader’s vision and possibly having the growth of the business at heart.

Against this backdrop, there must be a conscious effort to build a solid team. It is said that one is as good as his/her team. Therefore, a growth-leader must bear in mind to grow his team. The collective powers of the team under the effective supervision of the leader results in high performance which steers the growth wheel, thus, it is paramount to invest largely in developing the team.

This ranges from helping them develop their skill set, expanding their knowledge scope in their respective fields to providing little things like increasing their vocabulary. How? Small or big steps like enrolling the team is training programs, pay for them to attend seminars, buy books and share weekly reads with them. One cannot give what one doesn’t have.

The team can only reproduce what they know, make sure their pool of knowledge is so large and deep and they would draw when needed to always over-deliver set targets – pleasing the clients and accruing more business as a result; more deals, more profit. Again, the leader who grows his team also breeds a sense of trust and loyalty from his or her team. On average, after graduating from college, a millennial will change jobs four times before they are 32.

Most of them also don’t feel empowered on their current jobs. There is therefore the need for the team lead to consciously spend time and energy in developing the capacity and general ability of his team mates. For instance, a team’s social media manager in a team whose leader sets him or her up to be a Google certified digital marketer not only now has the capacity to take on more responsibilities for the team and add value to the team, but also appreciates his/her leader by remaining loyal to both the business and the leader; more value for less.

A great leader and a great team need a great structure to realize the business’ full potential. A business structure that works; one that eliminates time wasters like micromanaging, red taping and unnecessary bureaucracy. A system that is designed to work its best with little or no supervision. For instance, in a business operating system where productivity depends on 50% of the man power or human resources, outputs are likely to be higher than one relying on 80% of man power.

Automating systems eliminate chances of human errors and ensure that the best work is delivered to a client each time. Adopt modern technology to set targets, reminders, achievement scale, simplify the system, have a tracking and reporting framework that shows what is happening when it’s happening and who is responsible for what. This gives the opportunity to weed out non performing team members, reward performing once and modify strategies in order to meet set goals.

The time a leader spends in micromanaging his team could be used more productively in ventures like research into trends and better ways of exceeding client expectations. While it is true that people do the things you inspect and not those you expect, it is also imperative that one creates a system that does the monitoring on behalf of the leader to churn out great results and total progress on the growth ladder.

Achieve Set Goals and targets

The growth mind-set is backed strongly by the will to achieve and over achieve. This phenomenon also rests in the mind; that every challenge has a solution and that no mountain is too tall to climb, forms the mind-set an achiever. With an excellence-driven team under a growth mind-set leadership utilizing an efficient business model or procedure, consistently achieving is inevitable and more importantly business growth is not far from reach.

Growth-leadership mind-set incorporates the use of one’s mind-set to grow, taking productive action that is result oriented and finally achieving set goals and targets. In these disruptive times where new technology and innovations are springing up, one needs to be abreast with everything.

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