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Michael Raynor has a doctorate of business administration from Harvard and works for a big-name consulting firm so I had to overcome several deep-seated prejudices to read his new book The Strategy Paradox: Why Committing to Success Leads to Failure (and What To Do About It).

He’s from Canada, and I believe that I am a Canadian stuck in a Hawaiian body (vis-a-vis hockey), so I bent my rules about helping authors with such a pedigree (pedegree?). Luckily I did because his book is quite informative. I don’t know about you, but there are many companies that succeed, and I can’t figure out why. And there are also many companies that fail (some of which I invested in), and I can’t figure out why.

This book goes a long way in explaining how strategy makes or breaks a company. To put it another way, I won’t think I’m so smart if a company that I invest in succeeds, and I won’t think I’m so dumb if it tanks.

  1. Question: Why did Windows kick Macintosh’s butt and VHS kick Beta’s butt?

    Answer: Apple continued along the path that it had blazed with the Apple II and the Macintosh: very cool, very high-performing products built around a proprietary architecture of hardware-software integration. This was a perfectly reasonable bet to continue, but it happened to be the wrong one in the personal computer market of the late 1980’s. Like a broken clock, a
    strategy that never changes gets it right sometimes, though statistically it
    is wrong more often than not. The iPod is Apple’s latest hit, and it’s more of the same: a cool device built around a proprietary architecture. Apple’s clock hasn’t changed; it still reads twelve o’clock. It’s just that it happens to be noon again.

    By contrast, Microsoft built a series of strategic options that positioned the company for success under a variety of different outcomes. Microsoft had what turned out to be a better strategy only because it didn’t commit itself to a single strategy. For example, when IBM began aggressively creating a competitor to MS-DOS and Windows, OS/2, Microsoft collaborated with IBM. The Windows development effort is evidence of Microsoft’s belief in GUI OS’s, but Microsoft was also getting a foothold in applications development for GUI-based systems by writing Excel and Word for…Apple! Corporate customers seemed to think that UNIX had a promising future, and so Microsoft was investing in UNIX too even as it released new versions of the by-then venerable menu-driven MS-DOS.

  2. Sony, like Apple, similarly suffered the fate of a reasonable, but wrong, committment. It positioned the Betamax as a high-fidelity video recording device for time-shifting broadcast TV programs. In contrast, Matsushita’s VHS was a lower-performing, lower-cost device. Much to everyone’s surprise, using VCRs to view rented movies turned out to be the “killer app,” and recording fidelity became a secondary consideration.

    Sony couldn’t adapt by cutting costs and hence price because Matsushita was, by the mid-1980’s, millions of units ahead of Sony on the VCR experience curve: any move by Sony would have been easily countered. In other words, much as Apple had done in the PC market, Sony made a perfectly reasonable bet that turned out to be the wrong one. Matushita didn’t end up on the right end of this battle because it had a more strategically flexible stance than Sony as in the Microsoft/Apple case. Rather, Matsushita made a different bet that simply turned out to be the right one.

  3. Question: So Apple and Sony didn’t do anything “wrong” per se?

    Answer: You could say that Apple’s and Sony’s strategies were great strategies that simply happened to fail. They failed not because of any shortcomings in the strategies, but because of shortcomings in each firm’s ability to predict what sort of strategy would succeed. Trying harder to craft the perfect strategic moves won’t work; companies need to more effectively manage the uncertainty that necessarily colours every strategic decision.

  4. Question: What is the explanation for Toyota’s success?

    Answer: A big part of it was being well-positioned for the oil crisis of the mid-1970s. Toyota was influenced by its origins in the Japanese market, where size and fuel economy mattered, and in the U.S., it was focusing on the second car market, where the need for low prices similarly rewarded smaller, more fuel-efficient cars. When the oil crisis hit, Toyota happened to have products that were much better suited to the suddenly-changed environment.

    As Louis Pasteur said, “Fortune favours the prepared mind,” so this bit of luck would have been useless to Toyota if it made inferior cars. But of course customers quickly noted Toyota’s vehicle quality. This reflected its tradition of manufacturing excellence, of defect and cost reduction and quality improvement, a system that is known today as the Toyota Production System, or TPS.

    By the way, Toyota has been selling cars in the US since the mid-1950s. They’re #2 and threatening to become #1, but it took fifty years. GM overtook Ford as the #1 automaker in the early 1930s, less than twenty years after Alfred Sloan created GM. Toyota’s accomplishment is remarkable, but it took a long time.

  5. Question: You sure make it sound confusing: damned if you do, damned if you don’t—what’s a company to do?

    Answer: This is what I call the strategy paradox. That is, the same strategies that have the highest probability of extreme success also have the highest probability of extreme failure. In other words, everything we know about the linkage between strategy and success is true, but dangerously incomplete. Vision, commitment, focus…these are all in fact the defining elements of successful strategies, but they are also systematically connected with some of the greatest strategic disasters.

    For example, Apple’s strategy sometimes works great, and sometimes fails miserably. It’s not that Apple sometimes “forgets” what makes for greatness. It’s that what makes for greatness also exposes you to catastrophe. The same goes for Sony.

    To produce success, vision, commitment, and focus must be linked to an accurate view of what lies ahead, and nobody can adequately predict the future. If you can guess right on a regular basis, my hat’s off to you…and can I buy your stock? But no one—no one—has any legitimate claim to an ability to make predictions relevant to true strategic planning.

  6. Question: Why can’t companies predict the future better?

    Answer: Companies might be able to predict the future better than they can now, but for me the question is whether they will ever be able to predict the relevant future accurately enough for the purposes of strategic planning, and so avoid, or at least mitigate, the strategy paradox. I don’t think that’s going to happen anytime soon for some deep, structural reasons.

    For example, randomness. Prediction requires the identification of a pattern that repeats, because a pattern is what allows you to use what has happened to infer what will happen next. Randomness is the enemy of pattern-based prediction because randomness means that there is no pattern, no way to use the past to predict the future.

    In A New Kind of Science, Stephen Wolfram identifies three sources of randomness, the first two of which are relevant here. First, any system must have boundaries that define it, since any system without boundaries would be the universe itself. Second, no system is entirely closed. Therefore, every system is subject to exogenous, and necessarily unpredictable, shocks that introduce randomness into the system. And if you keep on expanding the boundaries to encompass the various externalities, you will need a theory of everything to have a theory of anything.

  7. Question: But what if there were a system that was self-contained and orderly?

    Answer: Unless we can specify the initial conditions precisely enough we cannot exploit that orderliness for the purposes of prediction. The problem is that we never really know what counts as “initial.” Exogenous shocks make it impossible to know where to stop defining a system, and sensitivity to initial conditions makes it impossible to know where to start.

  8. Question: What’s the proper role in strategy formation for each level in a hierarchy?

    Answer: I’ve found that it helps to think about strategy in two halves: the commitments that all successful strategies entail, and the uncertainties attendant to those commitments. Commitments and uncertainties are only half the answer. The rest of the solution lies in calibrating the focus of each level of the hierarchy to the uncertainties it faces. It is common sense—if not common practice—that the more senior levels of a hierarchy should be focused on longer time horizons. What hasn’t been as widely recognized is that with longer time horizons come greater
    levels of uncertainty, and strategic uncertainty in particular. This fact has some profound implications for how eacg level in an organization should act.

    • Board members should ask: What is the appropriate level of strategic risk for a firm to take? What resources should be devoted to mitigating risk? What sacrifices in performance are acceptable in exchange for lower strategic risk? This allows the board to be involved in strategy without getting involved in strategy making, which is correctly the purview of the senior management team.

    • CEOs should ask: What strategic uncertainties does the company face? What strategic options are needed to cope with those uncertainties? In other words, it falls to the CEO, and the rest of the senior team, to find ways to create the strategic risk profile the board has mandated for the firm.

    • Divisional or business unit vice-presidents should ask: What commitments should we make in order to achieve our performance targets? For these folks, it’s no longer about mitigating strategic risks, but making strategic commitments. Someone has to take the actions that create wealth, after all.

    • Managers should ask: How can we best execute on the commitments that have been made in order to achieve our performance targets? To put it on a bumper sticker, they have to “show us the money.” There are no strategic choices to make at this level, because the time horizons are too short—six to twenty-four months. Strategies simply can’t change that fast.

  9. Question: How does your answer change with respect to a start-up?

    Answer: Start-ups tend to be enormously resource constrained. Typically they are not able to devote money and time to the problems of strategic uncertainty. As a result, start-ups tend to be “bet the farm” propositions: high risk, with the potential of high reward. Such firms don’t manage strategic risk, they accept it.

  10. Question: Are you saying that by definition a startup is resource constrained, so it should/has to bet the farm on one approach?

    Answer: The degree to which you manage risk will be a function of your ability to bear risk and recover from setbacks. On the continuum from the archetypal “two people in a garage” to Johnson & Johnson, I take the counter-intuitive view that start-ups are much better able to bear risk: if the venture fails, the people and other resources involved are typically far more easily redeployed than is the case with large corporations.

  11. Question: So if a startup fails for other than poor execution and implementation, it’s “okay” because betting the farm is the way to go?

    Answer: I wouldn’t go that far. There is always room for thinking carefully about the risk you face and how to mitigate it effectively. You’ve suggested, for instance, that start-ups can think about betting on sectors, or “customers,” then trying to adapt their products, or betting on products, then adapting things like marketing or distribution to find the right customers. Either approach involves a “core” bet and a series of options on contingencies. Which approach makes the most sense will be a function of the risk implied and the cost of mitigating it.

  12. Question: So start-ups are wrong to simply accept strategic risk?

    Answer: Although accepting strategic risk is not necessarily bad, it can be unwise to just accept it without doing your homework first. It’s possible to go to the opposite extreme and squander resources on multiple investments that are styled as strategic options only to find that they actually undermine your primary strategy without securing the desired options. The common problem is not adequately assessing your firm’s risk profile and shaping it appropriately.