Devising strategies for success
[Editor’s Note: This article is part of a series on what causes a firm’s value to increase and will be in two parts.]
Do you remember what a law is, not in the legal sense, but laws like the laws of physics, engineering, weather, etc.? Sounds boring, correct? I think otherwise. Laws are statements of what causes what, and they allow us to make predictions. Laws are a description of an event that does not vary over all known conditions. For example, water boils at 212 degrees Fahrenheit at one atmosphere of pressure (sea level) no matter what. Laws in the physical sciences also allow us to predict things with great accuracy. This is how we landed people on the moon in 1969 and brought them back, how we saved Apollo 13 and how we can predict the arrival of hurricanes, to name just a few.
It would be nice to know if we have laws of business strategy that should be followed at all times. Think about this – if there are no laws of business strategy then every decision we make is really following rules of thumb that have been passed down from generations or practicing common sense at the time of the decision. Not bad if these have worked in the past. But were you perhaps just lucky? What if there are laws of business strategy that could help you outperform your industry averages by a wide margin?
In the business world, there are some laws or things that are close to laws. Economics has a few – supply, demand and prices. Finance may have some, but the predictive power for both is much less than in the physical science world. What about the predictive power for possible laws of business strategy?
In this article, I will discuss what I and other strategists think are the candidates for the first three laws of business strategy. In Part 2 of this article next month, we will discuss the second three candidates and discuss implications of the six candidate laws of business strategy:
Strategy Law #1: Your Industry “Nature” Determines the Average Profitability for All the Competitors in Your Industry
You might be surprised that about 40 percent of the level of your firm’s pro ts are caused by your industry’s nature, not your individual decisions. Ever wonder why the pharmaceutical industry has an average industry return on invested capital of nearly 40 percent, the steel industry has an average of 5 percent and the airlines industry 2 percent? Now, some pharmaceutical competitors have lower ROIC than the 40 percent average, and some steel and airlines competitors have higher ROIC than their abysmal industry averages (like Nucor Steel and Southwest Airlines). What causes the industry averages? It is the degree of hostility of bargaining that goes on against you and the other competitors that make up your industry. Implications: Your strategy needs to start with the brutal reality of the amount of hostility in your industry in which you currently play. You need to try to cope with this reality, try to influence it to your favor or consider packing up and leaving if the average industry ROIC continues to spiral downward and you have no ties that bind you.
Strategy Law #2: Prices and Costs Always Decline
“Wait a minute,” you might be saying. The automobile I just purchased was a lot higher priced than the same model I bought seven years ago. This law refers to the fact that if the functionality and benefits of a car were to stay the same over time, the cost to produce and the price charged would drop in predictable ways. Bain’s research (a leading strategy consulting rm) into this shows that industries such as microprocessors, VCRs and digital cameras have very fast reductions in industry costs and prices over time. Industries such as cars and DVDs have slower reductions in industry costs and prices over time. But this is a reality if firms do not do something to counteract this law. Successful firms add features and functionality to counteract this law and have prices oat upwards to what the market will bear. Implications: If you are not innovating, this law will drive your business to a low cost/low price ball game.
Strategy Law #3: Dominate Something, Do Not Be Spread Thin
Is it better to have a 5 percent market share in 30 markets or a 30 percent market share in five markets? In general, it is better to have 30 percent market share in five markets. This was Wal-Mart’s early success in dominating the rural discount retail market. We can measure a firm’s degree of dominating something (called strategic market position), and this measure directly causes increases in rm valuation. The reason is you can better manage costs while having customers with a higher willingness to pay to actually buy your products and services at the higher price. Implications: If you get spread too thinly and do not dominate something, your ROIC will suffer, sometimes horribly.
Next Up: The Laws of Strategy, Part 2
Bill Bigler is director of MBA programs and associate professor of strategy at LSU Shreveport. He spent 25 years in the strategy consulting industry before returning to academia full time at LSUS. He is the president of the board of directors of the Association for Strategic Planning, one of the leading professional associations in the field of strategy. He can be reached at bbigler@lsus.edu.
