Category Archives: Strategy

March 26, 2014 · 1:27 pm

Consistency in Strategy – Why is CVS stopping to sell Cigarettes?

This blog entry is about consistency in strategy. It talks about the benefits it can bring, and contributes some examples from our everyday life. Initially I was motivated to write about consistency by US pharmacy CVS’s recent announcement to terminate the sale of cigarettes.

“Good Strategy is Unexpected” – Richard Rumelt

It is interesting how the world reacts to a follow-through in strategy. I for my part find it not too surprising if a pharmacy, which should generally serve the mission of improving customer’s health, stops selling something that is incredibly endangering that very mission. All in all, people seem to perceive this as a sacrifice of short-term profits for growing profits in the long run, especially from the other and growing healthcare services (such as walk-in clinics) of the retailer. The often stated benefits are believed to be:

  •          Positive media exposure (as first to drop cigarettes)
  •          Internal motivation for employees
  •          Clear message to investors and customers

The media exposure appears to be very short termed to me. I find the benefits to be within the message being sent to employees, investors and customers as a whole. The employees and investors will be aware of no longer working for or being investing in a retailer also selling pharmaceuticals, but being involved with a company improving the health state of the American customer base. The customers will, not necessarily only because of this action, start to perceive the company as a healthcare provider – and cigarettes really just do not fit in.

I think the “sacrifice” will be rather low, especially in the long run. I read an interesting bit claiming that the margin on cigarettes is rather low (15%), so the store space could be better used with higher margin products (30%). Of course the sales from people coming to the stores for cigarettes, but buying more items than that, would have to be taken out of the increased profits. Sales are expected to drop by overall $2 billion, with $500 million lost from non-cigarette sales. This would result in a “sacrificed” of roughly $375 million in profits. But with overall cigarette sales going down in the US sales/profits are destined to decline anyway.

When it comes to generic strategies (i.e. low cost vs. differentiation) consistency in approach and action is even more vital. In those cases it is not just about soft facts such as employee perception of the company, but directly impacting pricing and cost structure of the business. In the last blog post Prof. Porter explained low-cost strategy and showed how dedicated one has to follow the decided path in order to gain competitive advantage. I was told a story by a manager at a company that decided to pursue a low-cost strategy, due to commoditization of its products. Their CEO would ask people to take pens from hotels during business trips to the office. While this was clearly not a method to reduce operating cost, it did send a clear message over culture to everybody in the organization. This was combined with a rigorous portfolio management process. Together this resulted in great strategy execution and doubled the company’s market capitalization within a few years. A similar company once used to be able to demand a premium price from differentiated products, but now competition from emerging markets put heavy pressure on the company. The approach should have been the same as with the above example; and in part it was, but the communication by management seemed uncommitted and the execution therefore lacked in effectiveness. The old strategy, wealth of the company and negotiation position was still engrained in minds of mid-level management and sales force. This resulted in a higher cost structure from slack control of costs and investments. Margins eventually came down further with increasing competition.

This is what Porter calls “stuck in the middle”. In those cases a company in neither the lowest cost provider, nor providing a superior offering. When looking around, one can find some examples in which this still works (e.g. airlines with government funding/ special hubs magically offering great service quality for a competitive ticket price) in somewhat regulated industries or not level playing fields.

This paradigm of consistency in strategy can be applied to other situations outside of business, too. What comes to mind are political crises such as the world financial crisis, which would require consistent actions such as system and structural changes in finance and education sectors. Currently we rather see a postponing of adverse effects.

The example I want to illustrate is long the lines of the US’s foreign policy. Not as a whole, but the dealing with terrorism, from a strategy and values perspective. When different decision makers need to come up with smaller policies and tactics, what bigger strategy are they referring to? I my opinion all the clichés about the US would be a great overall strategy. The US should aspire to be the society of equal rights, democracy and global philanthropists. So when it comes to anti-terror the approach derived from that should consider playing by the rules, i.e. no imprisonment without a trial, no torture, and no killing commandos in covered ops against US citizens. The US would aim to rather be a role model than a manipulative force. This would not only eliminate a lot of the recruits flocking to the US’s opposition, but also make it easier for allies to support any endeavors (due to less pressure from citizens) and for the soldiers, since they will have to face less collateral damage and mistreatment of prisoners. The dealing with NSA espionage etc. is a topic on its own, but should follow an overall democracy strategy, too.

For those of you who wish to further dive into the strategy of nations, I recommend having a look at Porter’s Competiveness of Nations.

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Video

Have Michael E. Porter explain Competitive Strategy to you

While working on another piece for this blog, I came across this great video from a rather old series of Harvard Business School videos. Please find my comment below.

http://www.youtube.com/watch?v=c4ZBVp8-9gA

If you want to save lot of money for executive education on strategy, just have Prof. Porter explain the generic strategies, 5 forces and details of a low-cost strategy. A truly great lecture.

In summary, every company has to watch out for five forces that shape the profitability of every industry. Although the 5 forces are often criticized for not capturing change or government regulations, Porter mentions these factors in his review. He also brushes over what he calls the generic strategies. This is a 2×2 matrix of scope (narrow/broad) and advantage (differentiation/low-cost), which allows a positioning and survival of several competitors in the same industry. I know people insisting on “lowest cost” but Porter talks about this, too. The main idea is that one has to pick a strategy and then follow through.

The examples and interviews he uses to illustrate a low-cost strategy might be a bit outdated, but one gets the point.

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February 18, 2014 · 5:38 pm
January 25, 2014 · 1:34 am

Consulting Merger Game (Part 3, Final)

In this third and final part of the “Consulting Merger Game” I would like to give a little bit more background on what might happen and why. To be honest, it took me so long to write this, because of the sheer diversity of opinions and models applicable out there. Hence I decided to keep this post brief and rather indicate sources for further reading.

Two years ago, during a strategy project in the chemicals sector, I came across A.T. Kearney’s Industry Consolidation Curve. The model’s rational is that every industry will, as time goes, undergo a certain degree of consolidation, until only two players remain. It also caters for the possibility of a following reduction of consolidation or something like a double dip before the highest level is reached. Some of the professionals I spoke to over the last weeks have similar ideas. They remembered the Big4 selling of bits of their consulting units (such as KPMG’s unit became Bearning Point) and favor the idea of a continuous back and forth. I however, think there is a merit in ATK’s theory and found some evidence in management consulting’s cost structure.

As John Gapper (FT) states:

“The firms being squeezed are the midsized consultants that lack scale but have higher costs than specialist boutiques.”

He continues and proposes that a global consulting company would need annual revenues of at least USD 2 billion in order to pay partners and conduct investments. In 2011 this hurdle was only reached by McKinsey, BCG and Bain, according to Kennedy Consulting Research and Advisory. In details these numbers are made up by partner salaries of USD 1.2 M to USD 1.5 M, and roughly USD 500 K per partner for development of personnel and product offerings. After all, ATK, Berger and Booz did not make the numbers. (FT)

As Gapper concludes, only the big players, and due to a different cost structure, the smaller boutiques will survive and even profit from the squeeze-out of the mid-sized firms. I expect, that as consultants will earn less (due to a shift of supply and demand, refer to 5 Forces) talent will eventually join the customer companies at a higher rate, thus increasing pressure on the industry even more.

Before I conclude this blog entry, I want to briefly come back to the Big4 and tech conglomerates (IBM, Accenture, etc.). Some boutiques seem to comfort themselves with the thought that clients will soon be confused with the offering of big firms, because they can never be sure of the quality they receive and who to talk to. I can definitely relate to this, since consulting is and most likely will continue to be a people business, with trust as a huge factor in the relationship between client and consultant. In terms of transactions, Gapper adds to these considerations by assuming that some old partners of the firms would be willing to sell out to the tech firms, while young partners are not willing to sacrifice their status and become glorified sales people (FT). This did not work too well in the past. A beautiful “protagonist” angle on the topic, to paraphrase my strategy professor. So, maybe the large players will be a rather temporary appearance.

Finally, even when faced with all these thoughts, many players in consulting do not seem to see any ongoing change neither the need to transform their own business model. Christensen summarizes this in his article and compares it to the change nobody wanted to see in the steel industry, which posted record profits just before completely collapsing. After Christensen made the case, I understand why consultants would argue in favor of being too big, established and after all too agile to be disrupted. Only time will show which steps would have softened the potential blow. For those of you interested Christensen’s article offers guidance for self-disruption, in light of one of his older works.

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November 14, 2013 · 10:50 am

Consulting Merger Game (Part 2)

This blog is the second part on changes in the strategy consulting industry. If you missed the last blog, please find it here.

As discussed before, the industry’s character has changed already. Apart from the mentioned mergers, one has to take notice of the fact that classic strategy work is today the source of only 20% of revenues for consulting companies such as McKinsey (see Christensen of HBS). In the following passages I would like to dig into what the relevant drivers are, and how profits are impacted.

Even if author Steve Denning (Blogger at Forbes) has his own idea of why Monitor went bankrupt and questions the validity of Porter’s Five Forces, I want to use that very model to analyze what is happening. Denning claims:

“What killed Monitor had nothing to do with competition among rivals, or risk of new entrants or threat of substitute products or bargaining power of customers. What killed Monitor was the fact that customers were not willing to pay sufficient for what Monitor was offering.”

Many business majors would ponder on such a statement, but with Denning originally being a lawyer , I think we need to walk him through the model (Mr. Denning, in case you read this, please excuse my small joke). It needs to be said that the overall idea of the model is that five forces shape the long-term profitability of any industry. (Porter)

To start things off, we can quickly brush over competition. One can see that aspects like continues growth , differentiated offerings and established brands keep competition from being too fierce, but the overall number of players is still fairly high. Which brings us to the next point: New entrants are, against Denning’s claim, also influencing the industry. New boutique firms, technology player and Big4 want a piece of the attractive margins, and the low entry barriers make it easy to join in.

These margins are also the reason for other threats, which the model and economists label substitutes. Christensen mentions two points in his article, which fit in beautifully here. For one he talks about the increase in firms offering technology driven solutions (such as Salesforce.com but also the recently introduced “McKinsey Solutions”) and Facilitated Networks of consultants (e.g. Gerson Lehrman Group). Further he gives a great example of how the US legal industry took a major hit, when companies started insourcing roughly 33% of legal services (i.e. under Jack Welch). Similarly large companies are nowadays setting up their own “inhouse” consulting departments. This too, inevitably, takes business and profits away from the consulting industry.

Finally, I will ignore the supplier force for now, even though talents take another big cut out of the margins, and move on to the final force of buyer power. Here Christensen also mentions an astonishing observation, which I feel combines the two aspect of transparency and democratization of knowledge. Businesses used to request consulting services for expert advice, in which the product was highly untransparent with regards to the analysis taken and the value added. Christensen claims that this is where the brands and also the high margins stem from. Actually the high fees were used as a proxy for high quality of the service by many customers. This is different in today’s world, since the industry’s fluctuation rate of 20% has released over 50.000 alumni of the major consulting firms into businesses all over the world. Thus companies now have staff and managers who are far more sophisticated in dealing with strategies, process optimization, and – most importantly – with consultants and their projects. As a result more and more standard tasks are being insourced, special jobs taken care of by focused specialists, and the actual benefits of contracting consultants are now more visible. Price and brand are no longer a proxy.

As you may see from this, nearly all forces are working against the consulting industry, which is why the existing players are experiencing extreme pressures and eventually industry consolidation.

So much for the industry structure. For insights on costs and an outlook on what change the industry can expect next, please stay tuned for my next blog.

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October 23, 2013 · 5:50 pm

Six lessons from Private Equity

Private Equity is often seen as the area for best practices in strategy execution, general management and shareholder value creation. The consulting firm L.E.K. continues this in their recent issue of “Executive Insights” (Volume XV, Issue 25).

“Private equity holds several notable advantages over public ownership, not least its ability to boost equity returns through creative leverage structures. […] It is managerial discipline and strong operational performance, not financial engineering, that explain private equity’s impressive results.”

L.E.K. backs this statement by comparing the performance of major indexes with the Cambridge Associates LLC U.S. Private Equity Index. While the mentioned index outperforms all of the usual benchmarks (e.g. Dow Jones, Nasdaq, S&P 500), I noted that the Dow Jones U.S. Small Cap Index is doing a pretty good job keeping up with private equity, maintaining a close parity and even outperforming during the 5-year period. This leaves the question whether private equity companies really are delivering outstanding performance, or whether it is mainly the size of the companies which is the main differentiator.

L.E.K.’s thesis is that public companies can learn from the PE-managed companies in the following areas:

  • Focused Investment Theses
  • Relationships, Relationships, Relationships
  • Objective and Systematic Analysis and Diligence
  • Strategy Activation
  • Top-Flight Management Team
  • Develop a Culture and Incentives Oriented Toward Performance

The elements that I want to point out are the following:

L.E.K. sees a clear difference between the strategy itself (here focused investment theses) and the implementation (i.e. strategy activation). The latter contains the usual identification of clear-cut goals and outcomes, while the strategy should give the basis of where and how one plans to compete. (See also: M. Porter on Strategy)

The most interesting take-away for me was the discussion of incentive schemes within private and public companies. L.E.K. points out that the personal investment of management into the company is a “skin in the game” scenario that is rarely seen in public companies. While public companies do use options, these are largely influence by the overall performance of the stock market, not the company. This is why a mix of “indexed options” and other incentives oriented towards long-term cash flow are recommended.

For the full article please go here: Full article by L.E.K.

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Video

First post: What is Strategy? And what is it NOT?

When discussing strategy with other professionals (mostly during business school) I felt that organizations are often lost in setting goal, targets and visions, creating something far from what I would consider a real strategy.

To approach this topic, I would like to share a short video of strategy guru Michael E. Porter of Harvard Business School.

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October 13, 2013 · 7:05 pm