Strategy as simple rules

The success of Yahoo!, eBay, Enron, and other companies that have become adept at morphing to meet the demands of changing markets can't be explained using traditional thinking about competitive strategy. These companies have succeeded by pursuing constantly evolving strategies in market spaces that were considered unattractive according to traditional measures. In this article--the third in an HBR series by Kathleen Eisenhardt and Donald Sull on strategy in the new economy--the authors ask, what are the sources of competitive advantage in high-velocity markets? The secret, they say, is strategy as simple rules. The companies know that the greatest opportunities for competitive advantage lie in market confusion, but they recognize the need for a few crucial strategic processes and a few simple rules. In traditional strategy, advantage comes from exploiting resources or stable market positions. In strategy as simple rules, advantage comes from successfully seizing fleeting opportunities. Key strategic processes, such as product innovation, partnering, or spinout creation, place the company where the flow of opportunities is greatest. Simple rules then provide the guidelines within which managers can pursue such opportunities. Simple rules, which grow out of experience, fall into five broad categories: how- to rules, boundary conditions, priority rules, timing rules, and exit rules. Companies with simple-rules strategies must follow the rules religiously and avoid the temptation to change them too frequently. A consistent strategy helps managers sort through opportunities and gain short-term advantage by exploiting the attractive ones. In stable markets, managers rely on complicated strategies built on detailed predictions of the future. But when business is complicated, strategy should be simple.     

Making strategy: learning by doing

Companies find it difficult to change strategy for many reasons, but one stands out: strategic thinking is not a core managerial competence at most companies. Executives hone their capabilities by tackling problems over and over again. Changing strategy, however, is not usually a task that they face repeatedly. Once companies have found a strategy that works, they want to use it, not change it. Consequently, most managers do not develop a competence in strategic thinking. This Manager's Tool Kit presents a three-stage method executives can use to conceive and implement a creative and coherent strategy themselves. The first stage is to identify and map the driving forces that the company needs to address. The process of mapping provides strategy-making teams with visual representations of team members' assumptions, those pictures, in turn, enable managers to achieve consensus in determining the driving forces. Once a senior management team has formulated a new strategy, it must align the strategy with the company's resource-allocation process to make implementation possible. Senior management teams can translate their strategy into action by using aggregate project planning. And management teams that link strategy and innovation through that planning process will develop a competence in implementing strategic change. The author guides the reader through the three stages of strategy making by examining the case of a manufacturing company that was losing ground to competitors. After mapping the driving forces, the company's senior managers were able to devise a new strategy that allowed the business to maintain a competitive advantage in its industry.     

Innovating for cash

Despite companies' almost fanatical worship of innovation, most new products don't generate money. That's because executives don't realize that the approach they take to commercializing a new product is as important as the innovation itself. Different approaches can generate very different levels of profit. Companies tend to favor one of three different innovation approaches, each with its own investment profile, profitability pattern, risk profile, and skill requirements. Most organizations are instinctively integrators: They manage all the steps needed to take a product to market themselves. Organizations can also choose to be orchestrators: They focus on some parts of the commercialization process and depend on partners to manage the rest. And finally, companies can be licensers: They sell or license a new product or idea to another organization that handles the commercialization process. Different innovations require different approaches. Selecting the most suitable approach, the authors' research found, often yields two or three times the profits of the least optimal approach. Yet companies tend to rely only on the mode most familiar to them. Executives would do better to take several different factors into account before deciding which tack to take, including the industry they're trying to enter, the specific characteristics of the innovation, and the risks involved in taking the product to market. By doing so, companies can match the approach to the opportunity and reap the maximum profit. Choosing the wrong approach, like Polaroid did, for example, can lead to the failure of both the product and the company. Optimizing their approaches, as Whirlpool has done, helps ensure that companies' innovations make money.     

Disruptive change. When trying harder is part of the problem

When a company faces a major disruption in its markets, managers' perceptions of the disruption influence how they respond to it. If, for instance, they view the disruption as a threat to their core business, managers tend to overreact, committing too many resources too quickly. But if they see it as an opportunity, they're likely to commit insufficient resources to its development. Clark Gilbert and Joseph Bower explain why thinking in such stark terms--threat or opportunity--is dangerous. It's possible, they argue, to arrive at an organizational framing that makes good use of the adrenaline a threat creates as well as of the creativity an opportunity affords. The authors claim that the most successful companies frame the challenge differently at different times: When resources are being allocated, managers see the disruptive innovation as a threat. But when the hard strategic work of discovering and responding to new markets begins, the disruptive innovation is treated as an opportunity. The ability to reframe the disruptive technology as circumstances evolve is not an easy skill to master, the authors admit. In fact, it might not be possible without adjusting the organizational structure and the processes governing new business funding. Successful companies, the authors have determined, tend to do certain things: They establish a new venture separate from the core business; they fund the venture in stages as markets emerge; they don't rely on employees from the core organization to staff the new business; and they appoint an active integrator to manage the tensions between the two organizations, to name a few. This article will help executives frame innovations in more balanced ways--allowing them to recognize threats but also to seize opportunities.     

ESG Investing in Emerging and Frontier Markets

The authors discuss the benefits of considering material environmental, social, and governance (ESG) factors when investing in emerging and frontier markets. Companies that operate in these markets face a myriad of operating challenges, and management teams that respond to such challenges effectively can achieve superior financial performance over time. They are able to grow faster, achieve higher profitability, reduce their cost of capital, and manage exogenous risks better than their peers. For investment managers, integrating sustainability into the analysis process provides a differentiated lens to identify companies that possess strong competitive advantages that can drive value creation over time. At the same time, it can help investment managers avoid companies that have embedded risks in their business model or operations that may not be entirely visible to the market. Finally, given the early‐stage nature of many of these markets and the sometimes uneven understanding of sustainability issues at a company level, the authors argue that active ownership can be an important driver of alpha generation by fund managers. Engaging constructively with board members and management teams to improve a company's ESG profile can help drive operational improvements, strengthen the risk management function, and upgrade investors’ perception of the quality of the management team.     

Will disruptive innovations cure health care?

It's no secret that health care delivery is convoluted, expensive, and often deeply dissatisfying to consumers. But what is less obvious is that a way out of this crisis exists. Simpler alternatives to expensive care are already here--everything from $5 eyeglasses that people can use to correct their own vision to angioplasty instead of open-heart surgery. Just as the PC replaced the mainframe and the telephone replaced the telegraph operator, disruptive innovations are changing the landscape of health care. Nurse practitioners, general practitioners, and even patients can do things in less-expensive, decentralized settings that could once be performed only by expensive specialists in centralized, inconvenient locations. But established institutions--teaching hospitals, medical schools, insurance companies, and managed care facilities--are fighting these innovations tooth and nail. Instead of embracing change, they're turning the thumbscrews on their old processes--laying off workers, delaying payments, merging, and adding layers of overhead workers. Not only is this at the root of consumer dissatisfaction with the present system, it sows the seeds of its own destruction. The history of disruptive innovations tells us that incumbent institutions will be replaced with ones whose business models are appropriate to the new technologies and markets. Instead of working to preserve the existing systems, regulators, physicians, and pharmaceutical companies need to ask how they can enable more disruptive innovations to emerge. If the natural process of disruption is allowed to proceed, the result will be higher quality, lower cost, more convenient health care for everyone.     

Competition and Insurance Twenty Years Later

We are honored to address the European Group of Risk and Insurance Economists and will take the opportunity to make some reflections on the rather uneasy relationship between insurance and competition. Economists generally prescribe competition as a solution for markets that do not work well. Competition allocates resources efficiently and encourages innovation and attention to what customers want. Insurance markets differ from most other markets because in insurance markets competition can destroy the market rather than make it work better. One of the dimensions along which insurance companies compete is underwriting—trying to ensure that the risks covered are “good” risks or that if a high risk is insured, the premium charged is at least commensurate with the potential cost. The resulting partitioning of risk limits the amount of insurance that potential insurance customers can buy. In the extreme case, such competitive behavior will destroy the insurance market altogether. A simple model illustrates.     

Strategy as active waiting

Successful executives who cut their teeth in stable industries or in developed countries often stumble when they face more volatile markets. They falter, in part, because they assume they can gaze deep into the future and develop a long-term strategy that will confer a sustainable competitive advantage. But visibility into the future of volatile markets is sharply limited because so many different variables are in play. Factors such as technological innovation, customers' evolving needs, government policy, and changes in the capital markets interact with one another to create unexpected outcomes. Over the past six years, Donald Sull, an associate professor at London Business School, has led a research project examining some of the world's most volatile markets, from national markets like China and Brazil to industries like enterprise software, telecommunications, and airlines. One of the most striking findings from this research is the importance of taking action during comparative lulls in the storm. Huge business opportunities are relatively rare; they come along only once or twice in a decade. And, for the most part, companies can't manufacture those opportunities; changes in the external environment converge to make them happen. What managers can do is prepare for these golden opportunities by managing smart during the comparative calm of business as usual. During these periods of active waiting, leaders must probe the future and remain alert to anomalies that signal potential threats or opportunities; exercise restraint to preserve their war chests; and maintain discipline to keep the troops battle ready. When a golden opportunity or"sudden death"threat emerges, managers must have the courage to declare the main effort and concentrate resources to seize the moment.     

Open-market innovation

Companies in many industries are feeling immense pressure to improve their ability to innovate. Even in these tough economic times, executives have pushed innovation initiatives to the top of their priority lists, but they know that the best ideas aren't always coming out of their own R&D labs. That's why a growing number of companies are exploring the idea of open-market innovation--an approach that uses tools such as licensing, joint ventures, and strategic alliances to bring the benefits of free trade to the flow of new ideas. For instance, when faced with the unanticipated anthrax scare last fall, Pitney Bowes had nothing in its R&D pipeline to help its customers combat the deadly spores. So it sought help from outside innovators to come up with scanning and imaging technologies that could alert its customers to tainted letters and packages. And Dow Chemical and Cargill jointly produced a new form of plastic derived from plant starches--a breakthrough product that neither company could have created on its own. In this article, Bain consultants Darrell Rigby and Chris Zook describe the advantages and disadvantages of open-market innovation and the ways some companies are using it to gain competitive advantage. By importing ideas from the outside, the authors say, companies can collect more and better ideas from different kinds of experts. Creative types within a company will stick around longer if they know their ideas will eventually find a home--as internal R&D projects or as concepts licensed to outside buyers. Exporting ideas also gives companies a way to measure an innovation's real value. However, the authors warn against entering into open-market innovation without properly structuring deals: Xerox and TRW virtually gave away their innovations and had to stand by while other companies capitalized on them.     

Funding growth in an age of austerity

Everyone knows that corporate growth--true growth, not just agglomeration--springs from innovation. And the common wisdom is that companies must spend lavishly on R&D if they are to innovate at all. But in these fiscally cautious times, where every line item of every budget in every company is under intense scrutiny, many organizations are doing just the opposite. They tighten their belts, subject nascent product-development programs to rigorous screening, and train R&D staffers to think in business terms so the researchers will be better able to decide whether an idea for a product or service is worth pursuing in the first place. Such efficiency measures are commendable, say authors Gary Hamel and Gary Getz. But frugality is not a growth strategy, they point out, and, in truth, there is very little correlation between corporate performance and the amount spent on innovation. Companies like Southwest, Cemex, and Shell Chemicals have shown that businesses don't have to spend a fortune on R&D to reap the benefits of innovation. To produce more growth per dollar invested, companies must produce more innovation per dollar invested. Hamel and Getz explain how businesses can dramatically improve their innovation yields. They offer these five imperatives: Increase the number of innovators among existing employees (whatever their job titles) by involving them in innovation processes and events. Focus on developing truly radical ideas--ones that change customers' expectations and behaviors and industry economics--not just incremental ideas. Look for innovation sources outside the organization, as well as inside. Increase the learning from small, low-risk experiments. And commit to long-term, consistent development efforts.     

When to ally & when to acquire

Acquisitions and alliances are two pillars of growth strategy. But most businesses don't treat the two as alternative mechanisms for attaining goals. Consequently, companies take over firms they should have collaborated with, and vice versa, and make a mess of both acquisitions and alliances. It's easy to see why companies don't weigh the relative merits and demerits of acquisitions and alliances before choosing horses for courses. The two strategies differ in many ways: Acquisition deals are competitive, based on market prices, and risky; alliances are cooperative, negotiated, and not so risky. Companies habitually deploy acquisitions to increase scale or cut costs and use partnerships to enter new markets, customer segments, and regions. Moreover, a company's initial experiences often turn into blinders. If the firm pulls off an alliance or two, it tends to enter into alliances even when circumstances demand acquisitions. Organizational barriers also stand in the way. In many companies, an M&A group, which reports to the finance head, handles acquisitions, while a separate business development unit looks after alliances. The two teams work out of different locations, jealously guard turf, and, in effect, prevent companies from comparing the advantages and disadvantages of the strategies. But companies could improve their results, the authors argue, if they compared the two strategies to determine which is best suited to the situation at hand. Firms such as Cisco that use acquisitions and alliances appropriately grow faster than rivals do. The authors provide a framework to help organizations systematically decide between acquisition and alliance by analyzing three sets of factors: the resources and synergies they desire, the marketplace they compete in, and their competencies at collaborating.     

The 2001 HBR list. Breakthrough ideas for today's business agenda

Business is shaped by ideas. But how do you separate enduring ideas from passing fancies? In this, the first edition of the annual HBR List, our editors spotlight five break-through ideas that are truly shaping the future of business. EVEN A GREAT BUSINESS MODEL IS NOT ENOUGH: The rise and fall of dot-coms left markets reeling and CEOs scratching their heads. The most important lesson of the debacle: squishy thinking about "business models" is no substitute for a distinctive strategy. CHANGE IS CHANGING: In recent years, pundits have urged executives to incite revolutions within their companies. But a growing group of experts now suggests that the best companies actually evolve through incremental change--change that builds on rather than subverts their heritage. EGO MAKES THE LEADER: By looking deeply into executives' psyches, we are beginning to unlock the enigma of leadership. While there will never be a single recipe for successful corporate stewardship, an understanding of the human ego can shed light on leadership's most fundamental components. ONLY CONNECT: In business organizations, what's really important about people is not their individual skills but the relationships they form with one another. By investing in "social capital," companies can often push their performance to a whole new level. THE BIOLOGY CENTURY DAWNS: In the twentieth century, product innovations tended to spring from physics. But in the new century, biology may be the central source of innovation. From genomics to biomimicry, the study of life promises to change what companies sell and even how they operate.     

Productive friction: how difficult business partnerships can accelerate innovation

Companies are becoming more dependent on business partners, but coordinating with outsiders takes its toll. Negotiating terms, monitoring performance, and, if needs are not being met, switching from one partner to another require time and money. Such transaction costs, Ronald Coase explained in his 1937 essay "The Nature of the Firm," drove many organizations to bring their activities in-house. But what if Coase placed too much emphasis on these costs? What if friction between companies can be productive? Indeed, as John Hagel and John Seely Brown point out, interactions between organizations can yield benefits beyond the goods or services contracted for. Companies get better at what they do--and improve faster than their competitors--by working with outsiders whose specialized capabilities complement their own. Different enterprises bring different perspectives and competencies. When these enterprises tackle a problem together, they dramatically increase the chances for innovative solutions. Of course, misunderstandings often arise when people with different backgrounds and skill sets try to collaborate. Opposing sides may focus on the distance that separates them rather than the common challenges they face. How can companies harness friction so that it builds capabilities? Start by articulating performance goals that everyone buys into. Then make sure people are using tangible prototypes to wrangle over. Finally, assemble teams with committed people who bring different perspectives to the table. As individual problems are being addressed, take care that the underpinnings of shared meaning and trust are also being woven between the companies. Neither can be dictated--but they can be cultivated. Without them, the performance fabric quickly unravels, and business partnerships disintegrate into rivalrous competition.     

Beyond offshoring: assess your company's global potential

In the past few years, companies have become aware that they can slash costs by offshoring: moving jobs to lower-wage locations. But this practice is just the tip of the iceberg in terms of how globalization can transform industries, according to research by the McKinsey Global Institute (MGI). The institute's yearlong study suggests that by streamlining their production processes and supply chains globally, rather than just nationally or regionally, companies can lower their costs-as we've seen in the consumer-electronics and PC industries. Companies can save as much as 70% of their total costs through globalization--50% from offshoring, 5% from training and business-task redesign, and 15% from process improvements. But they don't have to stop there. The cost reductions make it possible to lower prices and expand into new markets, attracting whole new classes of customers. To date, however, few businesses have recognized the full scope of performance improvements that globalization makes possible, much less developed sound strategies for capturing those opportunities. In this article, Diana Farrell, director of MGI, offers a step-by-step approach to doing both things. Among her suggestions: Assess where your industry falls along the globalization spectrum, because not all sectors of the economy face the same challenges and opportunities at the same time. Also, pay attention to production, regulatory, and organizational barriers to globalization. If any of these can be changed, size up the cost-saving (and revenue-generating) opportunities that will emerge for your company as a result of those changes. Farrell also defines the five stages of globalization-market entry, product specialization, value chain disaggregation, value chain reengineering, and the creation of new markets-and notes the different levers for cutting costs and creating value that companies can use in each phase.     

Eager sellers and stony buyers: understanding the psychology of new-product adoption

Companies that introduce new innovations are the most likely to flourish, so they spend billions of dollars making better products. But studies show that new innovations fail at a staggering rate. While many blame these misses on lackluster products, the reality isn't so simple. The goods that consumers dismiss often do offer improvements over existing ones. So why don't people purchase them? And why do companies keep peddling products that buyers are likely to reject? The answer, says the author, can be found in the brain. New products force consumers to change their behavior, and that has a psychological cost. Many products fail because people irrationally over-value the benefits of the goods they own over those they don't possess. Executives, meanwhile, overvalue their own innovations. This leads to a serious clash. Studies show, in fact, that there is a mismatch of nine to one, or 9x, between what innovators think consumers want and what consumers truly desire. Fortunately, companies can overcome this disconnect. To start, they can determine where their products fall in a matrix with four categories: easy sells, sure failures, long hauls, and smash hits. Each has a different ratio of product improvement to change required from the consumer. Once businesses know where their products fit into this grid, they can manage the resistance to change. For some innovations, major behavior change is a given. In those cases, companies can either wait for consumers to warm to the product, make the improvement so great that buyers get past their apprehension, or try to eliminate the incumbent product. Firms can also try to minimize buyer resistance by making products that are compatible with incumbent goods, seeking out those who are not yet users of the existing product, or finding true believers.     

Value innovation: the strategic logic of high growth

Why are some companies able to sustain high growth in revenues and profits--and others are not? To answer that question, the authors, both of INSEAD, spent five years studying more than 30 companies around the world. They found that the difference between the high-growth companies and their less successful competitors was in each group's assumptions about strategy. Managers of the less successful companies followed conventional strategic logic. Managers of the high-growth companies followed what the authors call the logic of value innovation. Conventional strategic logic and value innovation differ along the basic dimensions of strategy. Many companies take their industry's conditions as given; value innovators don't. Many companies let competitors set the parameters of their strategic thinking; value innovators do not use rivals as benchmarks. Rather than focus on the differences among customers, value innovators look for what customers value in common. Rather than view opportunities through the lens of existing assets and capabilities, value innovators ask, What if we start anew? The authors tell the story of the French hotelier Accor, which discarded the notion of what a hotel is supposed to look like in order to offer what most customers want: a good night's sleep at a low price. And Virgin Atlantic challenged industry conventions by eliminating first-class service and channeling savings into innovations for business-class passengers. Those companies didn't set out to build advantages over the competition, but they ended up achieving the greatest competitive advantages.     

Mandatory information disclosure and innovation: Evidence from the disclosure of operational information

We use a quasi-natural experiment wherein the Shanghai Stock Exchange requires listed companies in certain industries to disclose operational information and a staggered difference-in-differences model to examine the impact of mandatory information disclosure on corporate innovation. We find that companies subject to mandatory operational information disclosure show significantly increased innovation. This effect is pronounced for companies classified as non-state-owned enterprises, facing severe financing constraints and a high degree of shareholder tunneling behavior and in competitive and high-tech industries. Although mandatory operational information disclosure reduces their competitive advantage, companies appear to compensate by increasing innovation. Our study highlights the positive impact of mandatory operational information disclosure, indicating that it contributes to the high-quality development of both capital markets and companies.     

Getting offshoring right

The prospect of offshoring and outsourcing business processes has captured the imagination of CEOs everywhere. In the past five years, a rising number of companies in North America and Europe have experimented with this strategy, hoping to reduce costs and gain strategic advantage. But many businesses have had mixed results. According to several studies, half the organizations that have shifted processes offshore have failed to generate the expected financial benefits. What's more, many of them have faced employee resistance and consumer dissatisfaction. Clearly, companies have to rethink how they formulate their offshoring strategies. A three-part methodology can help. First, companies need to prioritize their processes, ranking each based on two criteria: the value it creates for customers and the degree to which the company can capture some of that value. Companies will want to keep their core (highest-priority) processes in-house and consider outsourcing their commodity (low-priority) processes; critical (moderate-priority) processes are up for debate and must be considered carefully. Second, businesses should analyze all the risks that accompany offshoring and look systematically at their critical and commodity processes in terms of operational risk (the risk that processes won't operate smoothly after being offshored) and structural risk (the risk that relationships with service providers may not work as expected). Finally, companies should determine possible locations for their offshore efforts, as well as the organizational forms--such as captive centers and joint ventures--that those efforts might take. They can do so by examining each process's operational and structural risks side by side. This article outlines the tools that will help companies choose the right processes to offshore. It also describes a new organizational structure called the extended organization, in which companies specify the quality of services they want and work alongside providers to get that quality.     

Strategic sourcing: from periphery to the core

As globalization changes the basis of competition, sourcing is moving from the periphery of corporate functions to the core. Always important in terms of costs, sourcing is becoming a strategic opportunity. But few companies are ready for this shift. Outsourcing has grown so sophisticated that even critical functions like engineering, R&D, manufacturing, and marketing can-and often should-be moved outside. And that, in turn, is changing the way companies think about their organizations, their value chains, and their competitive positions. Already, a handful of vanguard companies are transforming what used to be purely internal corporate functions into entirely new industries. Companies like UPS, Solectron, and Hewitt have created new business models by concentrating scale and skill within a single function. As these and other function-based companies grow, so does the potential value of outsourcing to all companies. Migrating from a vertically integrated company to a specialized provider of a single function is not a winning strategy for everyone. But all companies need to rigorously reassess each of their functions as possible outsourcing candidates. Presented in this article is a simple three-step process to identify which functions your company needs to own and protect, which can be best performed by what kinds of partners, and which could be turned into new business opportunities. The result of such an analysis will be a comprehensive capabilities-sourcing strategy. As a detailed examination of 7-Eleven's experience shows, the success of the strategy often hinges on the creativity with which partnerships are organized and managed. But only by first taking a broad, strategic view of capabilities sourcing can your company gain the greatest benefit from all of its sourcing choices.