Predictable Biases

It appeared that IBM's acquisition of a communications switch maker and AT&T's acquisition of a computer maker illustrated the path forward.

Another bias is that, faced with a wave of change, the standard forecast will be for a "battle of the titans." This prediction, that the market leaders will duke it out for supremacy, undercutting the middle-sized and smaller firms, is sometimes correct but tends to be applied to almost all situations.

For example, the "convergence" of computing and telecommunications had been predicted for many years.  It appeared that IBM's acquisition of a communications switch maker and AT&T's acquisition of a computer maker illustrated the path forward.   Like two sumo wrestlers, AT&T and IBM advanced to the center of the ring, preparing to grapple.  Then is was as if the floor beneath them crumbled, dropping both into a pit beneath.   The very foundations they had stood upon were eaten away by waves of change--the microprocessor, software, the deconstruction of computing, and the Internet.  Having a common fate was not the kind of convergence  that had even envisioned. 

ACTION POINT: Don't always assume that Titans will battle for supremacy.  Consider all of the shifts that may affect your industry.

Defining Business Purpose and Mission: The Customer

Who is the customer?

“Who is the customer?” is the first and the crucial question in defining business purpose and business mission.  It is not an easy, let alone an obvious question.  How it is being answered determines, in large measure, how the business defines itself.  The consumer-that is, the ultimate user of a product or service-is always a customer.

Most businesses have at least two customers. Both have to buy if there is to be a sale.  The manufacturers of branded consumer goods always have two customers at the very least: the housewife and the grocer.  It does not do much good to have the housewife eager to buy if the grocer does not stock the brand.  Conversely, it does not do much good to have the grocer display merchandise advantageously and give it shelf space if the housewife does not buy.  To satisfy only one of these customers without satisfying the other means that there is no performance.

ACTION POINT: Take one product or service that you are responsible for and determine how many kinds of customers you have for it.  Then figure out if you are satisfying all of your different kinds of customers, or if you are ignoring some category (ies) of customers.

Predictable Biases

For instance, people rarely predict that a business or economic trend will peak then decline. 

In seeing what is happening during a change it is helpful to understand that you will be surrounded by predictable biases in forecasting.  For instance, people rarely predict that a business or economic trend will peak then decline.  If sales of a product are growing rapidly, the forecast will be for continued growth, with the rate of growth gradually declining to "normal" levels. 

Such a prediction may be valid for a frequently purchased product, but it can be far off for a durable good.    For durable products--such as flat-screen television, fax machines, and power mowers--there is an initial rapid expansion of sales when the product is first offered, but after a period of time everyone who is interested has acquired one, and sales can suffer a sharp drop.  After that, sales track population growth and replacement demand.

Predicting the existence of such peaks is not difficult, although the timing cannot be pinned down until the growth rate begins to slow.  The logic of the situation is counter intuitive to many people--the faster the uptake of a durable product, the sooner the market will be saturated.

ACTION POINT: Understand the trends and their limits of products in your business.

Deregulation

...they will have developed complex systems to justify their costs and prices, systems that hide their real costs even from themselves.

Many major transitions are triggered by major changes in government policy, especially deregulation.  In the past thirty years, the federal government has dramatically changed the rules it imposes on the aviation, finance, banking, cable television, trucking, and telecommunications industries.  In each case, the competitive terrain shifted dramatically.  

Some general observations can be made about this kind of transition.  First, regulated prices are almost always arranged to subsidize some buyers at the expense of others.  Regulated airline prices helped rural travelers at the expense of transcontinental travelers.  Telephone pricing similarly subsidized rural and suburban customers at the expense of urban and business customers.  Savings and loan depositors and mortgage customers were subsidized at the expense of ordinary bank depositors.   When price competition  took hold, these subsidies diminished fairly quickly, but the newly deregulated players chased what used to be the more profitable segments long after the differential vanished.  

This happened because of the inertia in corporate routines and mental maps of the terrain, and because of poor cost data.  In fact, highly regulated companies do not know their own costs--they will have developed complex systems to justify their costs and prices, systems that hide their real costs even from themselves.  It takes years for a formerly regulated company, or a former monopolist, to wring excess staff expense and other costs out of its system and to stop its accountants from making arbitrary allocations of overhead expenses to activities and products.   In the meantime, these mental and accounting biases mean that such companies can be expected to wind down some product lines that are actually profitable and continue to invest in some produce and activities that offer no real returns.

ACTION POINT: Understand your costs and avoid complex accounting systems that perpetuate inaccurate mental bias. 

Rising Fixed Costs

This increase may force the industry to consolidate because only the largest competitors can cover these fixed charges.

The simplest form of transition is triggered by substantial increases in fixed costs,  especially product development costs.  This increase may force the industry to consolidate because only the largest competitors can cover these fixed charges.

For example, in the photographic film industry, the movement from black-and-white to color film in the 1960s strengthened the industry leaders.  One insightful analysis of this wave of change points to is that in the previously mature black-and-white photo film industry, there was little incentive for competitors to invest heavily in R & D because film quality already exceeded the needs of most buyers.

But there were large returns to improvements in quality and the ease of processing color film.  As the costs of color film R & D escalated, many firms were forced out of the market, including Ilford in the United Kingdom and Ansco in the United States.  That wave of change left behind a consolidated industry of fewer but larger firms, dominated by Kodak and Fuji.

A similar dynamic was IBM's rise to dominance in computing in the late 1960's, driven by the surging costs of developing computers and operating systems.  Still another was the transition from piston to more sophisticated jet aircraft engines, cutting the field of player down to three: GE, Pratt & Whitney, and Rolls-Royce.

ACTION POINT: Watch for rises in fixed costs that may indicate a transition in your business.

Guideposts

Each guidepost is an observation or way of thinking the seems to warrant attention.

Driving or skiing in the fog is unnerving without any sure sign of orientation.  When a single recognizable object is visible in the mist, it provides a sudden and comforting point of reference--a guidepost.  To aid my own vision into the fog of change I use a number of mental guideposts.  Each guidepost is an observation or way of thinking that seems to warrant attention.

The first guidepost marks an industry transition induced by escalating fixed costs.  The second calls out a transition by deregulation.  The third highlights predictable biases in forecasting.  A fourth marks the need to properly assess incumbent response to change.  And the fifth guidepost is the concept of an attractor state.

ACTION POINT: Are any of the guideposts apparent in your industry?

The Nature of Freedom

Freedom is never a release and always a responsibility.

Freedom is not fun.  It is not the same as individual happiness, nor is it security or peace or progress.  It is a responsible choice.  Freedom is not so much a right as a duty.  Real freedom is not freedom from something; that would be license.  

It is freedom to choose between doing or not doing something, to act one way or another, to hold one belief or the opposite.  It is not “fun” but the heaviest burden lay on man: to decide his own individual conduct as well as the conduct of society and to be responsible for both decisions.

ACTION POINT: List specific goals for your work. Think of goals that will meet your need for personal fulfillment, while also helping your organization meet its performance objectives.  

Some Guideposts

Working with industry-wide or economy-wide change is even more advanced than particle physics-

It is hard to show your skill as a sailor when there is no wind.  Similarly, it is in moments of industry transition the that skills at strategy are most valuable.  During the relatively stable periods between episodic transactions, it is difficult for followers to catch the leader, just as it is difficult for one of the two or three leaders to pull far ahead of the others.  But in moments of transition, the old pecking order of competitors may be upset and a new order becomes possible.

There is not simple theory or framework for analyzing waves of change.  In the words of UC Berkley junior-physics professor, Nobel laureate Luis Alvarez, "This course is labeled 'advanced physics' because we don't understand it very well."  He explained, "If there were a clear and consistent theory about what is going on here, we would call this course 'elementary' physics."

Working with industry-wide or economy-wide change is even more advanced than particle physics--understanding and predicting patterns of these dynamics is difficult and chancy.  Fortunately, a leader does not need to get it totally right--the organization's strategy merely has to be more right than those of its rivals.

ACTION POINT: If you can peer into the fog of change and see 10 percent more clearly than others see, then you may gain and edge.

Discerning The Fundementals

To make good bets on how a wave of change will play out you must acquire enough expertise to question the experts.  

The work of discerning whether there are important changes afoot involves getting into the gritty details.  To make good bets on how a wave of change will play out you must acquire enough expertise to question the experts.  

As changes begin to occur, the air will be full of comments about what is happening, but you must be able to dig beneath the surface and discover the fundamental forces at work.  Leaders who stay "above the details" may do well in stable times, but riding a wave of change requires an intimate feel for its origins and dynamics. 

ACTION POINT: Dig below the surface of change and understand the details of what is driving it.

Using Dynamics VI

You must dig beneath this surface reality to understand the forces underlying the main effect...

When change occurs, most people focus on the main effects--the spurts in growth of new types of products and the falling demand for others.   You must dig beneath this surface reality to understand the forces underlying the main effect and develop a point of view about the second-order and derivative changes that have been set into motion.

For example, when television appeared int eh 1950s it was clear that everyone would eventually have one an that "free" TV entertainment would provide strong competition to motion pictures.  A more subtle effect arose because the movie industry could no longer lure audiences out of their homes with "just another Western."  Traditional Hollywood studios had been specialized around producing a stream of B-grade movies and did not easily adapt.  By the early 1960s, movie attendance was shrinking rapidly.  What revived Hollywood film was a shift to independent production, with studios acting as financiers an distributors.  Independent producers freed from the nepotism and routines of the traditional studio, could focus on assembling a handpicked team to make a film that might be good enough to pull an audience off of their family-room sofas.  Thus a second-order effect of television was the rise of independent film production.

ACTION POINT: Look for second order effects behind the waves of change in your industry.

Using Dynamics V

The challenge is not forecasting but understanding the past and present. 

After a wave of change has passed, it is easy to mark its effects, but by then it is too late to take advantage of its surge or to escape its scour. Therefore, seek to perceive and deal with a wave of change in its early stages of development.  

The challenge is not forecasting but understanding the past and present.  Out of the myriad shifts and adjustments that occur each year, some are clues to the presence of a substantial wave of change and, once assembled into a pattern, point to the fundamental forces at work.  The evidence lies in plain sight, waiting for you to read its deeper meanings. 

ACTION POINT: What does the evidence laying in plain sight say about change in your industry?

Role of the Bystander

…the bystander sees things neither actor nor audience notices.

Bystanders have no history of their own.  They are on the stage but are not part of the action.  They are not even audience.  The fortunes of the play and every actor in it depend on the audience, whereas the reaction of the bystander has no effect except on himself.  But standing in the wings-much like the fireman in the theater-the bystander sees things neither actor nor audience notices.  Above all, he sees differently from the way actors or audience see.  Bystanders reflect, and reflection is a prism rather than a mirror; it refracts.

To watch and think for yourself is highly commendable. But “to shock people by shouting strange views from the rooftops is not.”  The admonition is well taken.  But I have rarely heeded it.

ACTION POINT: Be a bystander to figure out what has to be done in your organization.  

Using Dynamics IV

Most of the foundations of what we now see as the "modern world" were put in place...

Compare the changes during your life to those that occurred during the fifty years between 1875 and 1925. During those fifty years, electricity first lit the night and revolutionized factories and homes.  In 1880, the trip from Boston to Cambridge and back was a full day's journey on horseback. Only five years later, the same trip was a twenty-minute ride on an electric streetcar; with the streetcar came commuting and commuter suburbs.  Instead of relying on a single giant steam engine or whiter wheel to power a factory, producers switched to electric motors to being power into every nook and cranny.

The sewing machine put decent clothing within every one's reach.  And electricity powered the telegraph, the telephone, and then the radio, triggering the first significant acceleration in communications since the Roman roads.  During that fifty-year period, railroads knit the country together.  The automobile came into common use and revolutionized American life.  The airplane was invented and commercialized.  Modern paved highways were build and agriculture was mechanized.  IBM's first automatic tabulating machine was developed in 1906.  A huge wave of immigration changed the face of cities.  Modern patters of advertising, retailing, and consumer branding were developed--hundreds of famous brands, such as Kellogg's, Hershey's, Kodak, Coca-Cola, General Electric, Ford, and Hunt's date from this era.  Most of the foundations of what we now see as the "modern world" were put in place, and great still-standing industrial empires were established.  All of this took place in the fifty years between 1875 and 1925.

Now, look at another, more modern, period of fifty years.   Since the 50's, television has reshaped American culture, jet air travel has opened the world to ordinary people, the failing costs of long distance transport have generated a rising tide of global trade, retail stores the size of football fields now dot the landscape, computers an cell phones are ubiquitous, and the Internet has made it possible to work, seek out entertainment, and shop without leaving home.  Millions can instantly tweet about their evanescent likes and dislikes.  Yet, all in all, the last fifty years' changes have had a smaller impact on everyday life and the conduct of business than did the momentous changes that occurred from 1875 to 1925.  

ACTION POINT: Historical perspective helps you make judgements about importance and significance.

Using Dynamics III

...believing that today's changes are huge, dwarfing those in the past, reflects an ignorance of history. 

An exogenous wave of change is like the wind in a racing boat's sails.  It provides raw, sometimes turbulent, power.  A leader's job is to provide the insight, skill, and inventiveness that can harness that power to a purpose.   You exploit a wave of change by understanding the likely evolution of the landscape and then channeling resources and innovation toward positions that will become high ground--become valuable and defensible-as dynamics play out.

To begin to see a wave of change it helps to have some perspective.  Business buzz speak constantly reminds us that the rate of change is increasing and that we live in an age of continual revolution.  Stability, one is told, is an outmoded concept, the relic of a bygone era.  None of this is true.  Most industries, most of the time, are fairly stable.  Of course there is always change, but believing that today's changes are huge, dwarfing those in the past, reflects an ignorance of history. 

ACTION POINT:   Maintain a long perspective when looking at the waves of change in your industry.

Using Dynamics II

Important waves of change are like an earthquake, creating new high ground and leveling what had been high ground.

One way to find fresh undefended high ground is bey creating it yourself through pure innovation.  Dramatic technical inventions, such as Gore-Tex, or business model innovations, such as FedEx's overnight delivery system, create new high ground that may last for years before competitors appear at the ramparts.

The other way to grab the high ground is to exploit a wave of change.  Such waves of change are largely exogenous--they ate mostly beyond the control of any one organization.  No one person or organization creates these changes.  They are the net result of a myriad of shifts and advances in technology, cost, competition, politics, and buyer perceptions.  Important waves of change are like an earthquake, creating new high ground and leveling what had been high ground.  Such changes can upset the existing structures of competitive positions, erasing old advantages and enabling new ones.   They can unleash forces that may strengthen or radically weaken existing leaders.  They can enable wholly new strategies.

ACTION POINT: What are the forces of change creating new high ground in your industry or market?

Using Dynamics

 How do you attain such an advantaged position in the first place?

In classical military strategy the defender prefers the high ground.  It is harder to attack and easier to defend.  The high ground constitutes a natural asymmetry that can form the basis of an advantage.

Much of academic strategy theory concerns more and more intricate explanations for why certain types of economic high ground are valuable.  But such discussion sidestep an even more important question: How do you attain such an advantaged position in the first place?

ACTION POINT: As valuable as advantaged positions are, the cost of capturing them is even higher.  And an easy to capture position will fall just as easily to the next attacker.

Human Factor in Management

Management is about human beings.

The task of management is to make people capable of joint performance, to make their strengths effective and their weaknesses irrelevant.  This is what organization is all about, and it is the reason that management is the critical, determining factor.

Management must be built on communications and on individual responsibility.  All members need to think through what they aim to accomplish – and make sure their associates know and understand that aim.  All have to think through what they owe to others – and make sure that others understand. All have to think through what they, in turn, need from others – and make sure others know what is expected of them.

ACTION POINT: Management must enable the enterprise and each of its members to grow and develop as needs and opportunities change.

Strengthening Isolating Mechanisms

When an isolating mechanism is based on the collective know-how of groups, it may be strengthened by reducing turnover. 

An isolating mechanism inhibits competitors from duplicating your product or the resources underlying your competitive advantage.  If you can create new isolating mechanisms, or strengthen existing ones, you can increase the value of the business.  This increased value will flow from lessened imitative competition and a consequent slower erosion of your resource values. 

The most obvious approach to strengthening isolating mechanisms is working on stronger patents, brand-name protections, and copyrights.  When a new product is developed, its protection may be strengthened by stretching an already powerful brand name to cover it.  When an isolating mechanism is based on the collective know-how of groups, it may be strengthened by reducing turnover.  When protections are unclear, legislation or courtroom verdicts may clarify and strengthen certain positions.

ACTION POINT:  Identify and strengthen the resources that provide any competitive advantage you have.

Creating Higher Demand

Engineering higher demand for the services of scarce resources is actually the most basic of business stratagems.

A competitive advantage becomes more valuable when the number of buyers grows and/or when the quantity demanded by each buyer increases.  Technically, it is the scarce resources underlying the advantage that increase in value.  Thus, more buyers for small airplanes will increase the value of Embraer's (Brazil) brand name and its specialized skills in design and production.  Note that higher demand will increase long-term profits only if a business already possesses scarce resources that create a stable competitive advantage. 

Because so many strategy theorists have mistakenly equated value-creating strategy with "having" a sustainable competitive advantage, they have largely ignored the process of engineering increases in demand.  Engineering higher demand for the services of scarce resources is actually the most basic of business stratagems.

ACTION POINT: Identify your resources that will create a stable competitive advantage and create demand for those.

Broadening the Extent of Advantage III

...a failure in the new arena can rebound to damage the core.

Extensions based on proprietary know-how benefit from the fact that knowledge is not "used up" when it is applied; it may even be enhanced.  By contrast, extensions based on customer beliefs, such as brand names, relationships, and reputation, may be diluted or damaged by careless extension.

Although great value can sometimes be created by extending these resources, a failure in the new arena can rebound to damage the core.

ACTION POINT: Avoid careless extensions of your brand that may end up damaging your core.

Broadening the Extent of Advantage II

Bemused by the idea that their company's competitive strength lies in vaporous generalities...companies may diversify into products and processes they know nothing about.

The idea that some corporate resources can be put to good use in other products or markets is possibly the most basic in corporate strategy.  Its truth is undeniable yet it is also the source of great mischief.  Bemused by the idea that their company's competitive strength lies in vaporous generalities such as "transportation," "branded consumer products," or "management," companies may diversify into products and processes they know nothing about.

The basis for productive extensions often resides within complex pools of knowledge and know-how.  For example, DuPont started as a specialist in explosives.  After World War I, its skill at chemistry and chemical production led DuPont to manufacture cellulose, synthetic rubber, and paints.  The work in synthetics led to new skills in polymer chemistry, which, in turn, left to Lucite and Teflon in 1935.  Similar patterns of accumulating and extending technological resources can be found in General Electric, IBM, 3M  and many pharmaceutical and electronics companies.

ACTION POINT: Identify any complex pools of knowledge and know-how to extend any competitive advantage you may have.