By: Chris Bradley, Martin Hirt, Sven Smit
26 MINUTE AUDIO / 3,400 WORDS (10 PAGES)
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Have you experienced strategy meetings that promise a Hockey Stick breakout growth that rarely materializes? Do you feel that the social dynamics in the strategy room might have reduced breakthrough ideas to safe bets? And even when strategy succeeds, the results are often just modest. What happened?
Based on deep empirical research on thousands of companies, McKinsey Partners Chris Bradley, Martin Hirt and Sven Smit provide a data-driven “outside view” to overcome social dynamics and create effective strategy. This book offers ten performance levers that dramatically increase chances of out-performing your competitors and creating breakout growth.
TOP 20 INSIGHTS
Survey shows that 70% of executives say that they don’t like the strategy process and 70% of board members don't trust the results.
Strategy is challenging because it deals with low-frequency, and high-uncertainty problems that are prone to cognitive biases. These biases typically reinforce favorable narratives. A study found that 80% of executives believed that their product stood out against the competition, while only 8% of the customers agreed.
The economic profit graph of companies follows a power law with a long flat middle and tails that rise and fall at exponential rates. Companies in the top quintile capture nearly 90% of all economic profits. Their average economic profit is $1.4 billion a year as compared to a mere $47 million for companies in the middle.
This Power Curve is growing steeper with time. The companies in the top quintile collectively made $684 billion in economic profit from 2010 to 2014 while the bottom quintile made a collective loss of $321 billion. From 2000 to 2004, the corresponding figures were much lower at $186 billion and $61 billion respectively.
Companies compete not only in their industries or their market segments. As far as capital is concerned, they are also competing against every other player in the world. Companies that started in the top quintile in 2004 garnered nearly 50 cents of every new dollar invested. Moving up the Power Curve is therefore imperative.
Nearly 50% of a company’s position in the Power Curve is determined by their industry. It’s much better to be an average company in a great industry than to be a great company in an average industry. For example, the median pharmaceutical or technology company would be in the top 10% of food product companies.
Success is defined as moving up the Power Curve. Companies that jump from the middle to the top quintile gain an average increase of $640 million in annual economic profit. This requires big moves that out-perform competitors.
A recent survey found that CEO’s attributed only 50% of target-setting decisions to facts and analytics. The remaining 50% was due to the dynamics in the strategy making process.
The Power Curve is sticky. The general odds of a company moving from the middle to the top quintile over 10 years is just 8% percent. 78% of firms in the middle quintiles, 59% of those in the top quintile and 43% of firms in the bottom quintile remained at the same position ten years later.
Among 101 companies that moved up a quintile, two-thirds of the time it was due to just one business unit creating the breakout. Correctly identifying that business unit and feeding it the resources it needs for breakout growth can determine your organization’s progress on the Power Curve.
The probabilities for individual companies moving up the power curve can vary from 0 to 80%. Ten performance levers grouped into endowments, trends and moves can predict the probability of success. Roughly, endowments determine 30%, trends 25%, and moves 45% of the probability of moving up the curve. This provides an outside view to analyze the quality of strategy.
Of the 117 organizations that moved up a quintile, 85 moved with their industry. If an organization faces an unfavorable trend, then there are two difficult options ahead: transform the industry to change its growth prospects and gain competitive advantage or shift industries. Neither option is easy and the social dimensions make it much harder.
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Strategies tend to focus on incremental improvements and not on big moves. Breakthrough ideas are reduced into safe bets and resources are spread thin across all verticals irrespective of growth potential. Why does this happen?
THE SOCIAL SIDE OF STRATEGY
Social dimensions including individual bias and group dynamics can overpower the best of strategic intent. A key reason for this is the fact that strategy rooms are excessively focused on the “inside view” - data about your organization, key competitors and your own industry. The insider view creates distortions in strategic planning. The picture presented is mostly overly optimistic. Ultimately, the presentation shows a Hockey Stick Curve with an initial dip and a subsequent exponential breakout. This is used to bargain for resources or create sandbags to make sure targets are achieved. Either way, the predicted growth rarely materializes.
Social games are played because people’s egos, status, the resources they get, and careers depend on how they present their growth strategy. Strategy is challenging because it deals with low-frequency, high-uncertainty problems that are prone to cognitive biases. Further, there are agency problems that arise due to misalignment between management and other stakeholders. Some of them are:
Sandbagging: Individual managers create excessively safe plans that they are sure to achieve.
Short Termism: The tendency to milk gains in the short run which may have long term consequences.
My Way or Your Problem: Managers may use not getting the resources they demanded as an excuse not to deliver.
The Numbers Game: Managers may spend their time optimizing for the metrics by which they are evaluated, ignoring other equally important factors.
Incentive mismatch: While CEO’s optimize for the overall success of the organization, managers tend to look out for their business units and their employees. Managers also know that they have to over project to get the resources they actually need.
The social side of strategy ultimately leads to the Peanut Butter Approach where resources are evenly spread across all units, even though some have far greater growth opportunities. What is needed is an “outside view” - data from thousands of organizations and strategies to objectively benchmark strategy.
THE POWER CURVE
Economic Profit, the total profit after subtracting the cost of capital, is a good indicator to measure by how much a company has beaten the market. The authors graphed the economic profit of 2,393 of the largest non-financial companies between 2010 to 2014 from highest to lowest. They found that these companies follow a power law with a long flat line in the middle and tails that rise and fall at exponential rates.
This was divided into three regions: the bottom of the curve was represented by the first quintile of companies, the middle of the curve covered the second, third and fourth quintiles, while the top of the curve covered the top quintile in economic profit. The average profit in the top of the curve is 30 times more than the middle of the curve. As the vast majority of the profits are in the top quintile, the goal of strategy must be to escape the broad middle and move into the top.
SHIFT TO THE OUTSIDE VIEW
The Power Curve brings a fundamental shift in strategic thinking. The comparison is with companies across the world for capital and economic profit. Success is now defined as moving up the Power Curve. Companies that jump from the middle to the top quintile gain an average increase of $640 million in annual economic profit.
KNOW YOUR ODDS
The Power Curve is sticky. The odds of a company moving from the middle to the top quintile over a 10-year period is just 8% percent. 78% of firms in the middle quintiles, 59% of those in the top quintile and 43% of firms in the bottom quintile remained at the same position ten years later. Among 101 companies that moved up a quintile, two-thirds of the time it was due to…