Right strategy—Wrong problem

Strategies go awry when management’s internal frame of reference is out of touch with the realities of the businesssituation. Here’s advice on how to put your strategies on a sound foundation.

Right Strateg-y-Wrong Problem JOSEPH C. PICKEN trategies are about the future-and, for better or worse, the future is largely unknown. As a result, organizational strategies tend to be based, in considerable measure, on assumptions, premises, and beliefs about an organization’s environment (society and its structure, the market, the customer, and the competition), its mission, and the core competencies needed to accomplish that mission. Peter Drucker calls this set of interrelated assumptions the “theory of the business.” Gary Hamel and C.K. Prahalad, in Competing for the Future, expand this concept, maintaining that “every manager carries around in his or her head a set of biases, assumptions, and presuppositions about the structure of the relabout how one makes evant ‘industry,’ money in the industry, about who the competition is and isn’t, about who the customers are and aren’t, about which technologies are viable and which aren’t, and so on.” For the strategist, this internal frame of reference serves both as a road map and as a constraint on thought processes. The best-laid strategies go awry when management’s map fails to chart the realities of the business situation-when one or more of management’s assumptions, premises, or beliefs are incorrect, or when internal inconsistencies among them render the overall “theory of the business” no longer valid.

S

GREGORY G. DESS LESSONS FROM THE REAR-VIEW MIRROR The consequences of an invalid theory are clearly apparent in the wild ride Dallas-based Greyhound Lines, Inc. has given its investors. The box on the following page tells the story. This case history and the others that follow present a compelling argument for testing assumptions before implementing a strategy-a subject covered in the second half of this article.

Wrong Paradigm As the story shows, things were looking good for Greyhound by the end of 1992. Ridership continued to trend down, but load factors and yields had steadied and the aggressive cost cutting was beginning to show on the bottom line. Greyhound eked out a narrow profit in 199~its first since 1989-and Wall Street rewarded it. The company’s stock soared, from about $12 to over $21 per share. By May 1993, a $100 million stock offering was completed and the company moved ahead with its new reservations system. There was good reason for everyone to be optimistic. But before the celebration begins, let’s take a look at Schmeider and Doyle’s key assumptions. They started with the premise that the bus business was fundamentally the SUNER

1998

35

In the 1960s nearly30 percentof all interstatetravelwas by bus. Dozensof bus companiesoperatedacrossthe country, but GreyhoundLines,Inc., was the only companywith a nationwideroutesystem.Theinterstatebus industry’sprimary competitionwas the privateautomobile-hence Greyhound’sfamiliaradvertisingslogan, “Leavethe drivingto us.” Bythe 1980s however,market conditionshad changeddramatically.The interstatehighway system had been completedand almost everyfamily owned at leastone automobile.Airfareshad come down sharplywith deregulation, and the 35 percentannualgrowth rate of commuterairlinesin the mid-80s extendedthe reachof the airtransportation networkinto manycommunitieswhere buseshad beenthe only sourceof publictransport. Bythe early90s lessthan 6 percentof all interstatetravelwas by bus. Greyhoundas well as Trailways,Inc. (the numbertwo carrier)had grown through the acquisitionof regionalcarriers duringthe 50s and 60s when the marketwas expanding.But in the late 70s passengertraffic beganthe steady declinethat continued into the 90s. The industry entered a period of consolidationand retrenchment. Greyhound acquiredTrailwaysin 1987 and combinedthe two companies.A new managementteam aggressivelydownsized,shedding workersand assets,consolidatingoperations,and reducingschedules.By 1989, the combinedfleets had shrunk from more than 6,000 busesto lessthan 3,900. In 1990, managementtook an aggressivestand againstthe unions and their antiquatedwork rules. A bitter labor battle ensued,with the strikingdriversfiring shots at the busesas non-unionreplacementskept them rollingdown the interstates.Asthe turmoil continued,ridershipdeclinedand lossesmounted. Both sides dug in and held their ground. Crippledby the impasse,the companyfiled for bankruptcyin early1991. ByOctober1991, Greyhoundemergedfrom Chapter11 in the handsof a new managementteam: CEOFrankSchmeider,formerlyan investmentbanker,and CFOJ. MichaelDoyle,a financialexecutivewith a backgroundin the oil business. The problemwith Greyhound,in theirview,was that the old bus industrymodel no longerworked.Reengineeringwas in vogue,and the solutionappearedobvious:adopt a new businessmodeland reengineer-what else?The businessmodel they chosewasthat of the airlineindustry.The similaritieswere obvious.Bothairlinesandbuseswerein the people-moving business,both were asset-intensive,substantialportionsof their operatingcostswerefixed, revenuewas both cyclical and seasonal,and assetutilizationwas the keyto profitability.Theairlineshad addressedtheseproblems,in part, by developinghub-and-spokeroutestructuresand sophisticatedcomputerizedreservationsand yield-managementsystems. Theturnaroundplanthey devisedin late1991 was well receivedon WallStreet.It beganwith downsizing-the number of buseswas slashedby 35 percent;maintenancefacilitiesby half, and employeesand ticket salesoutlets by 25 percentby the end of 1992. Many old-linebus companyexecutivesand terminalemployeeswere sacked;part-timers and low-paid “customer-serviceassociates”replacedsome of them. Schmeiderand Doylerevampedthe route structure, cut capacity25 percent by eliminatingsmall-townstops, and trimmed unprofitableroutes, Revenuescontinued to decline,but an aggressivenew marketingplan was in the worksto reversethe trend. The plan’s cornerstonewas a new $6 million computerizedreservationsystem, known as TRIPS,under developmentby a contract programming house.The new system,scheduledfor nationalroll-out in mid-l 993, would permit the companyto make better useof its assets,increaseload factors, and improverevenueyields Passengertraffic would be rebuiltby using guaranteed reservations,discountedadvancepurchasefares, localpromotions,and “frequentrider” plansto attractnew riders,all of which mimickedairlinemarketingtechniques. Note: This case study and other anecdotalmaterialhas been adapted from Mission Critical: TheSevenSfrafegic Trapsthat DerailEventhe Smartest Companies(Chicago:Irwin ProfessionalPublishing,1997) by permissionof The McGraw-t-tillCompanies. 36

ORGANIZATIONAL

DYNAMICS

same as the airline business. Having accepted that premise, a whole series of additional assumptions logically followed: (a) the airline business model would work in the bus industry; (b) the major difference between the airlines and Greyhound was in marketing; (c) a computerized reservations system was the key to improved marketing and the more efficient management of bus operations; (d) it would be simple and inexpensive to develop a reservation system based on the airline model; and (e) even though revenues were declining, costs could be cut even faster, buying time to implement the new marketing strategy. Unfortunately, almost every assumption they made was incorrect. The differences between the airline and bus industries were greater than they appeared on the surface. While even large airlines typically have only a few hundred aircraft and serve less than 200 cities, Greyhound operated 2,400 buses and over 2,600 terminal locations. Average oneway bus fares of $33 were about a tenth of the typical airline fare. The demographics and purchasing habits of the customer base were markedly different. The typical rider earned less than $17,000 per year and bought a ticket at the terminal a few hours before departure. Airline-style pricing, reservations, and promotional efforts failed to attract this type of customer. The development of the reservations system was far more difficult and took longer than originally anticipated. When initially tested, it failed miserably. Management, unwilling to admit that the system wasn’t ready, pushed ahead with the scheduled July 1993 launch. The results were disastrous. The system was overwhelmed. The new toll-free reservations number was swamped-on average, customers had to try a dozen times before they got through to make a reservation. It frequently took five minutes or more to print a ticket and the lines at the terminals got longer. Even worse, according to Jack Haugsland, Greyhounds current chief operating officer, “Over 80 percent of those who made reservations were no-shows.” With a nearly empty

bus waiting outside, people were standing in line with cash in hand waiting to buy a ticket, but “the system wouldn’t let you sell [them] a ticket....Pretty soon, people get discouraged and quit coming down to the terminal,” Haugsland observed. Greyhound was hemorrhaging cashrevenues were down 12.6 percent and losses totalled $72 million in the first nine months of 1994. By the end of the third quarter, Schmeider and Doyle were out and an interim management team was preparing another Chapter 11 filing. Craig Lentzsch, a bus industry veteran, ultimately replaced Schmeider, and the new management averted bankruptcy through a financial restructuring. The problems with the phone system have been fixed-customers now get through on the first try. Former bus industry executives were rehired. By late 1995, Lentzsch was well on the way to turning things around, with a third quarter profit of $15.3 million after six consecutive losing quarters.

Back to the Basics What was his secret? Run it like a bus company! Lentzsch’s first step was to dismantle the airline business model and scrap the reservation system. He replaced the concept with a much simpler one: “If you want to travel by bus, you show up at the terminal and within a reasonable time you get a seat on the bus at an affordable price....If we fill up the bus that is supposed to leave at 10 a.m., we will keep rolling out buses until everyone has a seat,” Mr. Lentzsch explains. The second step was to change the pricing structure-the discounts for advance purchase reservations yielded to an “everyday low price” structure. The company increased frequencies on popular routes and now runs hourly shuttles between Boston and New York, with service every half-hour on the weekends. The new strategy appears to be working. The traditional bus riders are coming back. The decline in revenues has been reversed and Greyhound was solidly profitable for the full year 1996. SUMMER 1998

37

Greyhound represents an extreme case. Rarely does one encounter a situation in which a new management team attempts to change the entire paradigm. More frequently, strategies fail because: (a) they are based on overly optimistic or unrealistic assumptions, or (b) perfectly reasonable and valid assumptions are overtaken by events that were not foreseen in the beginning.

AN OVERDOSE OF OPTIMISM Optimistic assumptions are not uncommonnew managers frequently believe that they have a better idea and are willing to bet significant sums that their instincts are correct. Raytheon executives clearly thought they had it figured out when they acquired Beech Aircraft. The story of the Beech Starship, presented at the right, shows how a great idea, based on a set of questionable premises, didn’t pan out. Raytheon made a number of key assumptions in its strategy for the Beech Starship. The first related to the design. Beech assumed, as it announced in 1983, that it could complete the design and achieve FAA certification for the all-composite aircraft in two years. The key to the design lay in the anticipated weight savings: Carbon fiber composites are 350 percent stronger than aluminum but 15 to 20 percent lighter. By building the plane from these materials, the aircraft could carry a heavier payload farther and faster than a conventional turboprop, with significantly better fuel economy than a jet. The second assumption related to the FAA. Although existing regulations did not address the new carbon-fiber technology, Beech’s new managers must have assumed that the regulators would work within the spirit, rather than the letter, of the regulations. The third assumption was about the market. Beech had every reason to believe, based on the enthusiastic response and initial flurry of orders, that a significant number of aircraft would be built, justifying the investment in a new factory. What happened ? Murphy showed up, 38

ORGANIZATIONAL

DYNAMICS

Goodldeas Don’tAlwaysFly: TheBeechStarshipStory In the early 198Os,RaytheonCo., eagerto reduce its dependenceon the highlycyclicaldefensebusiness, acquired Wichita-based Beech Aircraft. Beech’straditional core business-light aircrafthad virtually collapsed during the 1970s as aggressivetrial lawyers chased deep pocketsand won mega-judgmentsfor the victimsof privateaviation mishaps. Aviationproduct liabilitypremiums soaredand the manufacturersheadedfor their foxholes All the major domesticmanufacturersof singleenginelight aircraft exitedthe business.The other two Wichita-basedaircraft manufacturers,Cessna and Learjet,were marketleadersin small corporate jets. Beech,a family-ownedcompany,continuedto hang on with the King Air, the leading corporate turbo-prop aircraft, but had not launched a new product in a decade. Raytheon installed its own management team after the 1980 takeover.Determinedto jump-start Beech’s business but unwilling to risk a head-on challengeto Cessnaand Learjet,they conceiveda bold plan-an advancedturbo-prop design based on the latestmaterialstechnology-that would provide performance competitivewith low-end business jets at a fraction of the cost. Originallyconceivedas a lo-passenger aircraft capable of 400 knot speed,the all-compositebody would be more fuel efficient than a jet, requireonly a single pilot, and sellfor only about $3 million(vs. $5 to 6 million for a comparable businessjet). Not only did the design, dubbedthe “Starship,”look great on paper, but an 85 percent scale model, demonstrated in 1983, drew rave reviews. Inundated with orders, Beechcommittedto an initialproduction run of 53 aircraft and announced that the plane would be ready for shipment in late 1985-only two years later.

wearing the badge of an FAA inspector. The FAA had never certified an all-composite aircraft and, according to Fortune, “No bureaucrat wanted to be remembered as the guy who had signed off too quickly on...a plastic airplane.” The 1983 prototype was classified as “experimental” and did not have to comply with the FAA‘s requirements for production aircraft. As the design progressed, the bureaucrats began to insist on compliance with the existing standards for metal aircraft. Composite fiber parts had to be redesigned to comply with the design rules for aluminum parts, resulting in an incredibly strong composite fiber aircraft that, in the end, weighed about as much as a metal one. As the weight increased, bigger engines were required. Bigger engines meant more fuel, which meant more weight-requiring a redesign of the structure-and so on. As the weight spiraled upward, the Starship outgrew the “light aircraft” category and moved into the “commuter aircraft” weight class. It now required not one, but two pilots (a requirement since waived). Murphy showed up again: The FAA was in the middle of a rewrite of the commuter aircraft standards, making them a moving target of regulatory chaos and obfuscation. The Starship finally made it to market in 19&9-four years late. While pilots gave it high marks for comfort and stability, the design didn’t come close to meeting its original performance expectations. The final version carried six passengers (vs. 10) at a cruising speed of 335 knots (vs. the target of 400) and cost almost $5 million (vs. the planned $3 million). Not surprisingly, the anticipated market never materialized. Through 1994, Beech had sold only 19 airplanes and leased an additional 10. More than 20 additional aircraft (a $100 million inventory) were completed and gathering dust in Wichita. The production line was shut down shortly thereafter and Raytheon announced its plans to discontinue marketing efforts. By contrast, Beech’s neighbor, Cessna, delivered nearly 400 comparably priced Cita-

tion II and Citation V jets during the same period. Beech’s conventional turboprop, the Ring Air 350, also continued to sell well. In this case, Beech’s business model was the same as those of its major competitors. Beech, Cessna, and Learjet each saw the same market opportunities, the same technologies, and the same channels of distribution. Beech’s current product offering, the King Air turboprop, competed with the low end of the Cessna and Learjet lines, but at a significant performance disadvantage. Raytheon’s strategy for Beech was bold, but appeared to make good sense. As the dominant producer of business turboprops, Beech could move up in performance with an advanced-design turboprop based on the latest defense-industry technologies that would compete effectively and win market share from its competitors at the low end of the business jet market. The strategy was based, however, on a number of key assumptions, none of which held up. When the FAA refused to bend in its interpretation of regulations based on an older technology, the failure of the design, in hindsight, became inevitable.

A New Set of Rules Both Greyhounds and Raytheon’s strategies failed because their basic premises were proved wrong and the resulting “product” fell short of the market’s expectations. In other cases, strategies have proved too feeble to sustain competitive advantage, not because their initial premises were wrong but because their perfectly reasonable and valid assumptions were overtaken by events that could not have been foreseen. Consider the case of General Motors and its drive to achieve cost and quality parity with its Japanese competitors, presented in the sidebar, on the next page. Cheerful as the NUMMI story may appear, the victory celebration didn’t last long. Unfortunately for GM, the rules changed. The sources of competitive advantage shifted-to design, marketing, and supply chain management. While GM and the SUMMER1998 39

rest of Detroit were focused on cost and quality, the Japanese seized the high ground on the new competitive battlefield. A study by John Lindquist of the Boston Consulting Group makes this point. In 1990-1994, Lindquist notes, the Toyota Corolla and the Geo Prizm both came off the same assembly line and cost the same to produce-an average of $10,300. Toyota, based on the strength of its reputation and brand image, sold 200,000 vehicles annually at an average dealer price of $11,100. GM, on the other hand, sold an average of 80,000 vehicles at a price of $10,700. Over the period, Toyota made $128 million more in operating profits from NUMMI than did GM. Downstream, its dealers made an estimated $107 million more from higher retail prices. Moreover, the superior service provided by the Toyota dealer network sustained and amplified the initial edge. Depreciating more slowly, a five-year-old Corolla now sells for 18 percent more than a similar Geo Prizm on the used car lot. As this example points out, the competitive arena is built on shifting sandsthings never remain stable for long-and as conditions change, so must the premises and the focus of an organization’s strategy. Unanticipated shifts in market conditions and the emergence of new technologies often play havoc with the best-laid plans and strategies.

The Web Arrives The rapid acceptance of the Internet and the World Wide Web as a major force in both consumer and commercial applications provides another example. Although the Internet has been around since the late 196Os, many of the major players in the industry, including the giant Microsoft, were surprised at how quickly the World Wide Web grabbed the interest and imagination of the mass market. See the sidebar, at right. Microsoft was not the only major player taken by surprise. IBM paid $3.5 billion in July 1995 to acquire Lotus Development 40

ORGANIZATIONAL

DYNAMICS

I

I

Winning theRace,bui losingthePrize: TheG~-~U~~/Story In the early80s it was widelybelievedthat outdated manufacturingtechniquesand processeswere the No. 1 competitiveproblemfor the Detroitautomakers. The “lean production”techniquesincorporated by the Japaneseautomakerswere responsiblefor an almost insurmountablecost and quality advantage. General Motors, still the world’s largest automaker,respondedwith a number of initiatives. Althoughthe Saturnprojecthas receivedmore publicity,GM and the rest of the domestic automobile industry have also learned a great deal from the 1983 jointventurewith Toyotaknownas NewUnited Motor Manufacturing,Inc. (NUMMI).The sprawling NUMMI facility in Fremont, California,produces a line of nearlyidenticalvehicles-the ToyotaCorolla and GM’sGeoPrizm-sold in the U.S.through two separatedistributionchannels. In the beginning, it was assumed that NUMMI would providea number of advantagesfor General Motors: (1) by building the cars on a common assembly line, GM would achieve manufacturing cost and qualityparitywith Toyota;(2) both GMand Toyotawould benefit from the economiesof scale associatedwith a largerproductionvolume; and (3) GM would learn how to build automobiles the “Japaneseway,” then leveragethis knowledgeinto an improvedcompetitivepositionfor its other product lines. Toyota would benefit from scale economiesand reducethe threat of punitiveimport dutieson one of its most popularmodels. Judged against the initial objectives, NUMMI appearsto have been a successfor both automakers. As GM and the other U.S. auto manufacturers learnedto focus on qualityand adopt lean production techniques, the Japanesecompetitiveadvantages in product costand qualitylargelyevaporated.

Corporation, primarily to gain access to Lotus’s market-leading Notes software designed to let organizations publish and share information across a private network. Three months later, Compaq Computer Corp., a high-profile Notes customer, announced plans to drop Notes in favor of a Web-based system for sharing information with its suppliers and distributors. In the marketplace, Lotus slashed prices and aggressively pursued market share before the Web-based systems could establish a beachhead. In the back room, the developers scrambled to update the proprietary Notes software to ensure its compatibility with the new de facto standard-Sun’s Java technology. The popular on-line services-Prodigy, Compuserve and America OnLine-were also thrown into turmoil. For several years, the proprietary on-line services mainly battled among themselves, scrambling to establish the largest possible subscriber base before Microsoft entered the arena in the fall of 1995. Meanwhile, the World Wide Web emerged as a substitute technology that threatened to obsolete the entire industry. According to Scott Kurnit, formerly second in command at Prodigy, the rise of the Internet “turns the model of the on-line services industry upside down.” Forrester Research analyst William Bluestein agreed: “Their whole proprietary model has been shattered....[They’re about to be] blown out of the water.” By the fall of 1997, Prodigy was gone, Compuserve’s customer base had been acquired by AOL, and AOL had reinvented itself as a gateway to the Internet with an impressive assortment of proprietary features and interfaces. In each of these examples, one significant event-the rapid emergence of the user-friendly World Wide Web-shattered the assumption base and turned strategic models inside-out. If the patterns of technology evolution run true to form, today’s assumption base may be out of date before the ashes of the last discredited version are cool.

Blindsided bytheWeb: If If’sSoBig,WhyDidn’tThey SeeIt Coming? Since the early 80s when Microsoft’s MS-DOS became the industry standard, the company has increasinglydominatedthe PCsoftwarebusiness,first in operatingsystems,then in applications.Recently, Microsoft’sWindowsNT has mounteda strongchallenge in network operating systems, and with the launchof the MicrosoftNetworkinthe fall of 1995,the company entered the market for on-line services. Microsoftwas seeminglyunstoppable,withthe ability to eventuallydominateeverymarketit entered,It was almostinconceivable that Microsoftwouldbe takenby surpriseinthe heart of its market,but it happened! Accordingto BusinessWeek, “Gateshas been caughtremarkably flat-footedbythe birthofthe raucous WorldWideWeb.He acknowledged as much lastMay [1995] when hefiredoff a widelyleakedinternalmemo urgingeveryemployeeto makethe Interneta top priority.”Bylate1995, NetscapeCommunications Corpand SunMicrosystems hadseiiedthe initiativeandweresetting the agenda.It’snot that Microsoftwas blindto the existenceor potentialof the WorldWideWeb-& proprietaryproductswere underdevelopment-rather,it appearsto havebeencaughtoff guardby thetiming. Gatesacknowledgesthat “Javais the language that is the darling of the industry right now. It’s a good exampleof how, in this industry, people are alwayslookingfor the nextthing that will unseatthe giants.” Netscape’schairman and founder, James A. Clark,commented, “The Internet basicallyblew apart [Microsoft’s] whole strategy.” While it’s far from clearthat Microsoft’s whole strategywas intatters, the companydoes appearto be scramblingto catch up, and doing so in a rather uncharacteristicway. Rather than pursue the inhouse development of proprietary technology, Microsoft pieced together a responsepartly based on technologies developed by others and announced that it would license and support the Javalanguagefrom Sun Microsystems. SlJMNER1998 41

THE COMMON THREAD: “RIGHT STRATEGY-WRONG PROBLEM” Where’s the common thread? How are these examples related? Every strategy is built on a foundation of assumptions and premises-an internal frame of reference that recreates, in the mind of the strategist, a model of the extevrealreality. In each case, strategies failed (some more catastrophically than others) because they were based on sets of assumptions and premises that, in the end, proved to be inconsistent with external reality. Misled by erroneous assumptions and implicit biases, the managers of Greyhound and Beech Aircraft embarked upon, then persisted in, failing strategies long after outsiders recognized the folly of their endeavors. General Motors, Microsoft, IBM, and the on-line service providers based their initial strategies on sets of premises that were, for the most part, correct. But as their markets evolved (in GM’s case over a number of years, in the computer industry in a matter of months) these organizations either failed to recognize that the rules had changed or adapted too slowly when circumstances rendered their initial assumptions invalid.

WHY DOES IT HAPPEN? An individual’s knowledge and assumptions about business operations in general, as well as his or her assumptions about an organization’s ability to compete, come from various sources-formal education, college and business school courses, seminars, company-sponsored training, and the like. But while each individual may see the world a little differently, the natural process of socialization and accommodation within an organization tends to produce, over time, a set of broadly shared assumptions about the organization and its industry. In addition, many organizations seek out and hire individuals with similar educational backgrounds, put them through the same indoctrination and training programs, and teach them the same rules of survival in that particular corporation. The more an organiza42

ORGANIZATIONAL

DYNAMICS

tion promotes from within, and the longer the tenure of the senior management team, the more these employees come to share a common view of the organization and its environment. Over time, this shared view may become more important in guiding management decisions than the objective reality it mirrors. This phenomenon is so common that it has been given a label-the dominant logic of the organization. Researchers have found that this process of social reinforcement often extends beyond the boundaries of the firm, as customers, suppliers, and competitors also become involved in a process of social interaction and reinforcement of a commonly shared set of “rules” for conduct and competition within an industry. These commonly held beliefs become institutionalized as part of the firm’s organizational fabric-reinforcing certain perspectives and excluding others-in the definition of business unit boundaries and the identification of competitors, in accounting and reporting systems, in decision-making processes, and in other organizational practices, policies, and procedures. As Hamel and Prahalad observe, “These premises ‘bound or ‘frame’ a firm’s perspective on what it means to be ‘strategic,’ the available repertoire of competitive stratagems, the interests that senior management serves, the choice of tools for policy deployment, ideal organizational types, and...limit management’s perception to a particular slice of reality. Managers live inside their frames and, to a very great extent, don’t know what lies outside.”

THE DANGERS LOGIC

OF DOMINANT

The dominant logic is a two-edged sword. On the positive side, a cohesive management team with common goals and a common perspective is more likely to make decisions and implement strategies with a minimum of disruption. If, however, a management team’s “theory of the business” is built on premises that are inconsistent with actual conditions, disaster is right

around the corner. This can happen in several ways, as the following discussion shows.

A Narrow-Minded

Perspective

The dominant logic becomes dysfunctional when it limits an organization’s vision to the narrow confines of its currently served markets. As Hamel and Prahalad observe, “Any company that defines itself in terms of a specific set of end product-markets ties its fate to the fate of those particular markets.” A company that defines itself solely in terms of its current industry may well miss opportunities created by technologies or market forces that will ultimately replace or redefine the current segment. In early 1994, the video game industry was shocked by the report that Sega Industries, Ltd., had captured a 63 percent share of the 16-bit game-player market during the 1993 Christmas season and was soon expected to pass industry leader Nintendo in total sales. Nintendo’s president, Yamauchi, was clearly focused on the market he currently served. Discounting the “multimedia revolution” as overblown hype, he vowed to “concentrate on just one point-improving the quality of games in the current market.” Sega’s president, Nakayama, viewed the world very differently, however, and prepared for competitive battles on multiple fronts as he projected that the multimedia revolution would produce “a tectonic shift in society.” Clearly their perspectives differed greatly. Which one was right? Only time will tell, but by the end of 1996, it looked like a dead heat, with both facing strong challenges from new entrants.

Living

in the Past

A company’s dominant logic is invariably linked more to the past than to the future. Researchers have demonstrated that managers’ mental representations of the world are based, predominantly, on historical information rather than on expectations about the future, and that individuals tend to discount

or ignore new information that is inconsistent with their current frame of reference. Reed Elsevier, the worlds largest publisher of academic journals, provides an illustration. The $5.5 billion company, with more than 1,100 separate journals in its portfolio, is in a unique business. The editorial content is contributed free by academic scholars who must publish to get tenure. Academic libraries are a captive market-faculty members insist that the libraries subscribe to their favorite journalsand prices are high. A one-year subscription to Neuroscience, for example, costs $3,775; a subscription to Bmin Research costs $14,000. The pre-tax margin on Reed Elsevier’s academic publishing operations is about 40 percent. Competition from electronic publishing is looming on the horizon, however, with more than 140 peer-reviewed journals already on the Internet by late 1995 and copies-ondemand services offering significant savings to individuals and university libraries. Reed Elsevier is apparently unconcerned. Herman Bruggnik, its co-chairman, insists that “The market we serve is perfectly happy with the product we deliver.”

Misreading

the Competition

Researchers have called attention to a number of “blind spots” in competitor analysis, noting that organizations frequently misjudge the boundaries of their industries, do a poor job of identifying their competitors, and make erroneous assumptions about them. By focusing primarily on the most visible aspects of a competitor’s operations, strategists often end up with an incomplete assessment of the competitors’ capabilities. They anticipate competitors’ moves based on extrapolation of past behavior, rather than on a more insightful interpretation of the competitor’s true strategic intent. In other words, they implicitly simplify the situation, assuming: (a) that the competitor’s reactions will follow historical patterns of behavior, or (b) that the competitor shares a common world view and will behave rationally in accordance with that perspective. When simplified assumptions are substiSUMMER

1998

43

tuted for a clear understanding, a variety of strategic errors may arise, including the socalled “winner’s curse.” This leads to overbidding in the acquisition marketplace; nonrational escalations of commitment in which decision makers make inappropriate decisions primarily to justify prior actions; and overconfidence in judgment, leading decision makers to believe that a rational third party would support their perspective-losing sight of the fact that the competitor is also subject to the same biased view.

Joseph C, Picken is president of Joseph C. Picken and Associates, a management consuiting firm that provides consulting services in the areas of strategy, operations and financial management, and turnaround management to mid-sized and emerging growth firms across a broad range of manufacturing and service industries. Founded in 1986, the firm focuses on the unique challenges of emerging growth firms in high technology industries. Dr. Picken also serves as a visiting assistant professor of organizational behavior and business policy at Southern Methodist University. During a business and consulting career spanning nearly 30 years, Dr. Picken has served as CFO of major operating units of several Fortune 500 corporations and in senior management positions in a number of high tech entrepreneurial companies. He has led an initial public offering, been involved in five successful turnarounds, and held CEO or COO positions in two NASDAQ companies. His industry experience includes electronics and heavy equipment manufacturing, transportation, aviation services, equipment leasing, computer hardware/software, and government contracting. Dr. Picken holds an AB in economics from Dartmouth College, an MBA in finance and accounting from The Amos Tuck School at Dartmouth, and a Ph.D. in business administration from the University of Texas at Arlington.

44

ORGANIZATIONAL

DYNAMICS

BUILDING A SOLID FOUNDATION Successful strategies are built with an internal frame of reference that meets two tests of consistency: (a) the assumptions and premises must be consistent with the external realities of the competitive environment; and (b) they be must internally consistent with each other. Drucker argues that, in addition to these tests for validity and consistency, the theory of the business must be known and understood throughout the organization. Moreover, because the theory is a hypothesis about things that are in constant flux-society, markets, customers, technology-it must be continually tested and revised to remain valid. Building and testing a solid foundation of assumptions and premises involves five separate, but closely related management activities: l Developing an understanding: making assumptions, premises and beliefs explicit; l Setting priorities: identifying the most critical assumptions and premises; l Testing for consistency: validating the assumption base; l Communicating: getting the organization involved; and l Monitoring and updating: testing the theory of the business. The following paragraphs describe each of these processes and provide guidelines on how to implement them.

Developing

an Understanding

The first step-identifying the assumptions that make up the “theory of the business” and making them explicit-is relatively straightforward but often time-consuming. For the many reasons described earlier, an organization’s assumptions and premises are typically embedded in a complex web of understanding, making it difficult to distinguish assumption from fact. Often, it is easier to ask a series of questions, beginning broadly with, What do we know (or assume) about our environment? Then narrow the focus to ask, What do we know (or assume) about OUYindustry? Our organization? And so on. Once the collective “knowledge base” has been articulated, the next question, How do we know this?, will help to distinguish between fact and assumption. It is usually easier to begin the analysis with the development of a common understanding and definition of the boundaries of “our industry.” This requires consideration of four interrelated issues: domain (where does the industry begin and end); customer groups (sectors to be served and their specific needs); customer functions (customer needs and purchasing patterns); and cviticul technologies (production, marketing, and administrative systems). These factors should be considered simultaneously; otherwise the firm will err in selecting its competitive arena. It is critically important, at this point, to consider the “industry” in the broadest possible context, taking into account the organization’s core competencies and looking beyond current products and customers to consider both new products and potential new customers. The focus can be sharpened progressively by asking why firm A is included in the industry, but firm B is not, etc. With the industry boundaries defined, it is appropriate to move on to a more detailed level of analysis. This should begin with at least a preliminary framework of assumption categories and then proceed to the identification of the organization’s key assumptions, one category at a time. In most cases, key assumptions about the general environment-economic, social, cultural, technological, and regulatory-

Gregory G. Dess holds the Carol Martin Gatton Endowed Chair in Leadership and Strategic Management at the University of Kentucky. He presently serves on the editorial boards of the Academy of Management Review and the Strategic Management Journal and recently completed two terms on the editorial boards of the Academy of Management Journal and the Journal of Management. His research on strategic decisionmaking, competitive advantage, and organization-environment relations has been published in many of the leading academic and practitioner journals. In 1994, Professor Dess taught at the University of Oporto (Portugal) on a Fulbright lectureship and recently returned to Portugal to conduct seminars for business executives. He has also taught in the MBA program at the Norwegian School of Management and conducted executive education programs in Norway. Dr. Dess received his bachelor of industrial engineering from the Georgia Institute of Technology and his Ph.D. in business administration from the University of Washington.

SlJmR

1998

45

can more easily be described in the context of the environment’s influence on the overall industry than on an individual firm. Assumptions about customers, current and potential competitors, partners, suppliers, and stakeholders are usually more firm-specific. It is also important to understand both the industry’s and the organization’s value chain-who the ultimate customer is, where and how value is created, what the key linkages and interdependencies are, how the firm’s value chain differs from that of its competitors, and what kinds of relationships exist between the firm’s key customers and suppliers and its competitors. Within the organization, it is important to understand the assumptions implicit in the cost structures, production technologies, sources of supply, and organizational structures and policies.

Setting Priorities The initial listing of an organization’s assumptions, premises, and beliefs is typically rather lengthy. Some of these assumptions will clearly be more important than others; some will be made with greater confidence; some will be relatively fixed, others likely to change. To make the process manageable, identify the most important assumptions and premises, monitor them closely, and weed out those that are relatively inconsequential. At least four criteria must be considered in evaluating each assumption: l How important is it to operating performance? l How important is it to strategic direction? l How confident are we that the assumption is correct?, and l How likely is it to change? If the key criterion is organizational performance-and it often is-financial sensitivity analysis can provide a good test of an assumption’s performance implications. A word of caution, however: Financial sensitivity analysis tends to focus on near-term performance rather than on longer-term strategies. Care should be taken to ensure that short-term 46

ORGANIZATIONAL

DYNAMICS

performance is balanced against other strategic criteria in determining which assumptions should be monitored closely.

Testing for Consistency Once the key assumptions have been identified, each should be tested for its “fit” with the realities of the external environment. In some cases, this is relatively straightforward; in others, some digging and analysis will be required. Next, evaluate the assumption set’s internal consistency. This is often the most interesting and stimulating part of the exercise, as the planning team compares key assumptions to each other, one pair at a time, and tests by asking, If this assumption is true, does the next one logically follow? Invariably, inconsistencies will surface, raising questions about the validity of the initial set. Continue the process, in an iterative fashion, until a reasonable consensus has been achieved.

Communicating Once validated, the key assumptions should be documented in an appropriate fashion and broadly shared with the management team and other key personnel. Everyone involved should know and understand the central premises underlying the organization’s strategy. The important boundary-spanners-the salesmen, purchasing agents, and engineers who have the most frequent contact with suppliers, customers, competitors, and industry peersshould be included, as they are often in the best position to identify external changes that may invalidate one or more of the assumptions.

Monitoring and Updating The key assumptions and premises should be monitored on an ongoing basis. Different approaches are possible, depending on the nature of the environment and the organization. Periodic formal reviews of the assumption base may be appropriate and are often the best way to ensure the internal consistency of the entire set. In other situations, functional

EXHIBIT

1

A STRATEGIC INVENTORY . ... .. ... ... ... ... ... .. ... .. .... .. ... .. ... ... ... ... ... ... .. .... .. ... .. ... ... ... ... ... ... ... ... ... Defining fhe boundariesof fhe compefifive

the suppliers?Arewe dependenton a limitednumber of sources? How critical are these relationships? How solid?

environment * Whatarethe boundariesof our industry?Whatisour servedmarket?Whatproducts-services do we provide? l Who are the customers? Who are the non-cus-

tomers? What is the differencebetweenthem? + Who are our competitors?Who are the non-competitors?What makes one firm a competitor and the other not? % What are the key competenciesrequiredto compete in this industry?Whereis the valueadded?

Definingthekeyassumpfions + Who is our customer? What kinds of things are important to that customer? How does he or she perceive us? What kind of relationships do we have?

& What are the bases for competition in our industry? What are the key success factors? How do we measure up? How about our competitors? l What trends and factors in the externalenviron-

merit are important to our industry? How arethey likelyto change? Overwhat time horizon? % Are we able, in assessing our knowledge and assumptions, to clearly separate fact from assumption?

Is ourassumption setinternallyconsisfenf? l

For each pair of assumptions, can we answer “yes” to the question: “If assumption A is true, does assumptionB logicallyfollow?

Doweunderstand therelativeimportance of eachof our assumptions? are important to this end user? How does he or

l Who is the ultimateend user?Whatkindsof things

she perceiveus? What kind of relationshipdo we have? + Who are our competitors?What aretheir strengths and weaknesses?How do they perceiveus? What can we learnfrom them?

l

In terms of its potentialimpacton performance?

F In terms of our levelof confidencein its validity? *In terms of the likelihoodand expectationof nearterm change?

F In terms of its strategicimpact? Who arethe potentialcompetitors?New entrants? What changesin the environmentor their behavior Areourkeyassumptions broadlyunderstood? would makethem competitors? F Havewe documentedand communicatedour key % Whatis the industry’svaluechain?Whereis value assumptions? To our key managers? To the added?What is the cost structure?How does our boundary-spanners?To other key employees? firm compare? How about our competitors?

l

l What technologiesare important in our industry?

Dowehaveaprocess forreviewing andvalidafing our

andpremises? Producttechnologies? Productiontechnologies? keyassumptions Deliveryand servicetechnologies?How does our F Is there a process in place? Are responsibilities firm compare? How about our competitors? assigned?Areperiodicreviewsplannedand scheduled? l What are the key factors of production?Who are SUMMER

1998

47

executives may be assigned to monitor those assumptions that pertain to their areas of expertise and to alert the rest of the team, on an ad hoc basis, to trends and events that may impact the validity of the assumption base. At a minimum, each organization should periodically devote a few hours, perhaps at the beginning of the planning cycle, to a collective review of the organization’s key assumptions.

A STRATEGIC

INVENTORY

Exhibit 1 presents our Strategic Inventory, a series of questions designed to assist the reader in relating the concepts and approaches outlined in this article to his or her own organization. Take the test yourself. Ask several other members of your organization to do the same, then compare the answers. The results may surprise you. Frequently, perceptions about key strategic issues and priorities vary considerably across functions and at different levels within the organization. At the very least, such an exer-

“There is nothing 48

ORGANIZATIONAL

DYNAMICS

cise is a useful starting point for a meaningful dialogue about the organization’s key assumptions-and an appropriate beginning for a thorough exploration and validation of your company’s “theory of the business.”

CONCLUSION There is much to be learned from the common experience of firms as diverse as Greyhound, General Motors, and Microsoft. As the naked Emperor discovered in Hans Christian Andersen’s classic fairy tale, The Emperor’s New Clothes, believing something doesn’t necessarily make it true. And the fact that the dominant logic of the Emperor’s court reinforced his folly was of little consequence when the truth was finally revealed.

To order reprints, call 800-644-2464 (ref. number 9582). For photocopy permission, see page 2.

wrong with your throat. Lots of people have trouble swallowing their pride.”

SELECTED BIBLIOGRAPHY This article has been based, in part, on our new book, Mission Critical: The Seven Strategic Traps that Derail Even the Smartest Companies (Chicago: Irwin Professional Publishing, 1997). A number of other authors have also emphasized the influence of an organization’s assumptions, premises, and beliefs in guiding and shaping its strategies. Peter Drucker’s recent Harvard Business Review article, “The Theory of the Business” (Sept-Ott 1994, pp. 95-104) emphasized the interrelatedness of an organization’s assumptions about its environment, its resources and capabilities, and the skills and competencies required to compete in its industry. Gary Hamel and C.K. Prahalad, in Competing for the Future (Boston: Harvard Business School Press, 1994), describe how an organization’s premises “frame” a firm’s perspective and thus limit management’s perception to a particular slice of reality. The processes by which top managers within an organization tend to develop a common view of the world were described by Linda Smirchich and Charles Stubbart in a 1985 article “Strategic Management in an Enacted World,” Academy of Management Review, Vol. 10, No. 4, pp. 724-736; and by C.K. Prahalad and Richard Bettis in a 1986 article, “The Dominant Logic: A New Linkage Between Diversity and Performance,” Strategic Management Journal, Vol. 7, pp. 485-501. The development of a common frame of ref-

erence, shared among the firms in an industry, was described by J.C. Spender in Industry Recipes: An Enquiry into the Nature and Sources of Managerial Judgement (Cambridge: Blackwell, Inc., 1989). Research in cognitive psychology has also provided useful insights into how managerial perceptions are influenced by individual assumptions, biases, and beliefs. For those interested in a deeper exploration of the cognitive processes involved, two articles by Charles Schwenk are recommended: “Cognitive Simplification Processes in Strategic Decision Making,“ Strategic Management Journal, Vol. 5 (1984), pp. 111-128; and “The Cognitive Perspective on Strategic Decision Making,” Journal of Management Studies, Vol. 25, No.1, pp. 41-55, 1988). See also a recent article by Charles Stubbart, “Managerial Cognition: A Missing Link in Strategic Management Research,” Journal of Management Studies, Vol. 26, No. 4 (1989), pp. 325-347. The performance implications of errors in management’s assumptions and perceptions have been addressed in two recent articles: Edward Zajac and Max Bazerman, “Blind Spots in Industry and Competitor Analysis: Implications of Interfirm (Mis)perceptions for Strategic Decisions,” Academy of Management Review, Vol. 16, No. 1 (1991), pp. 37-56; and Shaker Zahra and Sherry Chaples, “Blind Spots in Competitive Analysis,” Academy of Management Executive, Vol. 7, No. 2 (1993), pp. 7-28.

SUMMER

1998

49