Contextual Intelligence

Notes based on the article by Tarun Khanna

According to the author, we live in WEIRD – Western, Educated, Industrialized, Rich, Democratic societies, where everything from the concept of fairness to the realization of self differs from that found in the societies of the emerging nations. Even then, we behave as it’s a flat world wherein most of what worked in one place is expected to work at the other and we easily get confused and frustrated when it doesn’t.

It is here the relevance of contextual intelligence comes. Contextual Intelligence is about the ability to know the limits of our knowledge and to adapt that knowledge to an environment different from the one in which it was developed.

We tend to overestimate the ability about what can be ported across nations and cultures. And for companies who business and capabilities span multiple geographies, the negative impact of strategy build on that over confidence can be seen from the marketing department struggling to expand the business to the Information Technology department frustrated with the different levels of expectations and difficulties from outsourcing.

The author also gives some tips on ways to overcome the troubles of integrating with a market very different from that of your home country.

According to him, researching the new market’s institutional context is actually easy once you are willing to do it. But be warned, not all industrial area tracks data. Many times, you have to start an effort to collect data. But nevertheless, it’s possible.

Changing the persistent mental model you may have, can be hard. As an example, the author gives the example of China, where the economy is run pretty much in entirety by the government. And it’s efficient. Where as we have been living in Capitalist countries where the general belief is that the state is unimaginably incompetent to has to keep away from controlling industries.

General concept are adaptable, but specific dimensions may not be. The overarching strategy can probably remain the same. But how it’s implemented should be based on the knowledge about the domestic environment. For example, you might decide to rate employees based on performance at all the geographic location you operate. But what are the variables the performance would be measured should be adapted to local environment.

And change is, well slow; very very slow most of the times. You have to show patience, you have to show perseverance. A cultural change in the domestic business market for the better, which at times can be the way things are done in the WEIRD world, (more transparency, monitoring, regulation, responsible politics) can take a decade on average. So don’t expect things to change over night.

So what would be a better way to do business with a new market? Involving people who understand the new market well, hiring from local market for leadership positions, grooming more global business leaders with overseas posting are a few ways you might prepare to face the challenge of moving in the known unknowns.

 

Fostering innovation at workplace for ALL

Disclaimer: I work in technology and it may have profound influence in my outlook. Also the words and jargon I use might be from the IT world.

Employee skill rotation program: This would help to plant at least two of the many innovation seeds – skills and the culture of change. And this is not about sowing the seeds on just a chosen few as in a leadership development program; it’s to foster innovation as a cultural change in the entire organization. Just as traveler who has seen the world would be more knowledgeable and practical that someone who never stepped out of his hometown, an employee who has seen the professional world from different angles and perspectives is better equipped to face the challenges his profession throws at him.

Unless we are all Steve Jobs, we discover, invent and innovate by using the knowledge we gained in our past. And the best ones are always woven from our past experiences. (It’s not that formal training doesn’t help; even Steve Jobs relied on the lessons he learned in the calligraphy class when designing typefaces for Mac). An employee doing similar activities for too long (we all know at least a couple of people who have been doing the similar activity for a decade, don’t we?) develops competency in the tasks that he performs on a daily basis. He will know the processes that need to be followed and the policies in place that have to be considered when he is given a problem to solve. However, many times unknowing to him, working so long at repetitive tasks also would have tuned him to see the outside professional world from the perspective of his daily activities. Many times to the extent that he puts the boxes (so called procedures, policies, processes) in place first when he is given a problem to solve and then works around a solution that satisfies it. It does not occur to him that probably there are solutions out there that can solve the problem at hand in a better way all the while satisfying the issues for which the policies exist in the first place. In other words, out of the box thinking and innovation is not his cup of tea.

Exposure to different perspective is the key to unlearning from this kind of tunnel vision. For that it’ll be nice to have the staff move around and undertake work in different business model, technology, support architecture and the like in a safe and secure environment. It has to be ever so frequently, probably every few years, such that the employee gets sufficient exposure and experience in new functions that he performs every time. This empowers him to borrow the idea and way of thinking from the all the work he undertakes to come up with better integrated solutions to the problems thrown to him. In other words, it fosters innovative thinking. It has to be considered that the employee might feel threatened and stressed by the challenges of frequent changes in the scope & content of his work. And that’s why support and encouragement is so important in these scenarios.

Tap the honey pot – Front line employees: These are the people who deal with business users and customers most frequently. To put things in perspective, a customer is someone who takes your service or product. If you happen to do something that gets you to interact with the person using what you make or do, you are candidate for tapping innovative ideas. Front line employees know customers pain as they are the ones taking the brunt when something goes wrong with the service provided. They know things that can be done differently to bring greater value to the customer. And many times they have to deal with a multitude of problems in a variety of situation, which means they have experience and knowledge on many things that matters. Often they know more than the manager higher up who just consumes the information filtered up through mostly word of mouth. And we all know how well that usually goes!

So, form a group to champion the effort of tapping these rich sources. Identify the best ideas. Work together on solving those problems that gives the best bang for the buck. And don’t forget to keep this process iterative.

Innovation Killers

I can’t think this blog to be complete without posting a few thoughts from the HBR article authored by Clayton M. Christensen, Stephen P. Kaufman, and Willy C. Shih.

They present very valid points on some of the strategies and best practices that can kill innovation.

The authors take the first short at Discounted Cash Flow (DCF) and Net Present Value (NPV) calculations for deciding on the projects to be approved. Anyone who has taken a 2 days course on corporate finance knows the importance of making fair assumptions and projections and using DCF to put a dollar figure against each new project proposal. According to my professor, if you cannot get a thought into spreadsheet, then it’s not worth mentioning while deciding on project proposals. However, the authors of this article are questioning one of the basic assumptions made in corporate finance – the option of doing nothing. When you are to decide if a project is a GO or NO-GO, you are asked to see if the NPV of the project is positive or negative. If it’s positive, your project is a go. Vice versa is also true, which means, if the NPV of the project is negative, you are not supposed to approve the project as it depletes shareholder value. At this point, there is this assumption that if you do nothing, your company continues to exist in to the eternity by doing what it’s doing now and nothing more. And who doesn’t know that’s a fallacy? So the option of doing nothing is not really an option at all. So what if you have all projects with negative NPV and worse, some of the project looks like futuristic whose value is difficult to define. Because NPV is negative, do you go for the option of doing nothing? Um, this is tough. Kind of gives the feeling – I want to agree but on second thought I don’t want to agree.

The next one looks even more important. The Fixed cost and sunk cost and its impact on marginal cost analysis. The authors claim that, when you are assessing a new project, unless it’s just adding to what you are already making, the marginal cost is actually the full cost itself. Say, you are running a company that makes nuts and bolts. If you plan to use the same machinery to manufacture say a new tool and the reason that you are using the existing machinery is just because you can, then the authors are asking you to rethink to strategy. Because you are using existing machinery, you might believe that your marginal cost is less as you are not spending on fixed cost again. But in reality, you might be forfeiting your future capabilities by not investing in new machinery that’s more appropriate for making the new tool and the tools of the future. That being the case, when you are making the decision on a new project proposal, unless you are on an incremental project (such as increasing the capabilities to make more nuts and bolts of the same kind), be cognizant of the future opportunities and use the full cost of production as your marginal cost. That way you are giving a fair chance to new disruptive project that might initially look like a loser for increasing shareholder value.

The solution the authors suggest is not to consider corporate finance and strategy as two different subjects that are not well related. They are indeed closely related and you’ve to take an integrated approach when deciding on new projects. The authors go as far as to recommend accepting strategies and not projects!

Do I want to agree? Not sure. The professor’s words still ring on my ear – If you can’t get it into spreadsheet, it’s not worth mentioning.

 

What Is Strategy?

 This is a compilation of notes from the Michael E Porters’s namesake article.

Strategy is about unique and valuable positioning involving different set of activities and you do that by serving

1) few needs of many customers (“variety based positioning”). Lube provides lubrication service and just that for anyone with an automobile. The Vanguard Group provides an array of common stock, bond, and money market funds that offer predictable performance and rock-bottom expenses.

2) many needs of few customer (“need based positioning” more like traditional segmentation). Ikea offers all home furniture for young people who are looking for style. They offer child care service while customers shop targeting those with kids and no nanny!

3) many needs of many customers in a narrow market (“access based positioning”). Carmike Cinemas, for example, operates movie theaters exclusively in cities and towns with populations under 200,000

Strategic positioning Vs Operational effectiveness

Operational effectiveness is about performing similar activities better than your competitor. But Strategic positioning is about performing similar activities in different ways than your competitor there by preserving and showcasing what is different about your company. ah ha.

Total quality management, bench marking, time-based competition, outsourcing, partnering, re-engineering, change management are all tool for operational improvement. Because operational effectiveness is concrete and measurable, managers are lured into it.

A company needs to establish a difference that it can preserve for competitive advantage. Provide greater value to customers or provide same value at a lower cost. The innumerable activities that companies need to perform, if they do it in a leaner way results in cost efficiency. Efficiency can be achieved by better, faster work as well as by reducing defects, rework and similar pain points. But you differentiate from rivals by the activities you choose to perform as well as how well you do it.

Strategic trade-offs

Strategy needs you make trade-offs in competing; choosing what to do and what not to do! The argument is, without trade-offs, there would be no need for choice and thus no need for strategy. So strategy is also about making trade-offs in competing – I don’t want to believe this. I like strategy to be more of an integrated approach where you come up with smart ideas which does not involve trade-offs. Why trade-off? I want to keep all the best stuff in the best-est way.

Deciding which target group of customers, services and needs to serve is important in strategy. So is deciding not to server other customers, services or needs. So strict discipline and clear communication is vital to make trade-offs.

Strategic fit

Strategy is about creating a synergy, creating a fit between the activities in the company so as to make it harder for anyone to copy.- agreed. The bigger the array of activities, the harder it is for a competitor to imitate. It is also understood that each of the individual activities are done well. A fit enhances the positions uniqueness.

Types of fit:

1. Simple consistency: Just a consistency with all its activities. Vanguard has a low cost strategy and every thing they do is aligned with it. No big money managers and no intermediaries.
2. Activity reinforcing: Neutrogena offers their soap at high end hotels and hotels let it display Neutrogena name instead of hotels. Customers use it, like it and buys it from drug store when they see it.
3. Optimization of effort: I don’t understand this!

A fit also means that poor performance in one activity will reflect in other activities and so weakness are more easily exposed and prone to get attention. In the same way, improvements in one activity will reflect as payback through other activities too.

Strategic positioning should have a window of a decade or more since continuity fosters improvements in individual activities as well as in the fit across activities. Also, frequent change in fit can be very costly and bound to be ‘no strategy’.

Failures – Why do strategies fail?

Eagerness to grow. Unwillingness to make trade-offs. The overconfidence in the need to capture all the market instead of a selected few. Offer all services instead of the ones in which you have developed competency. (isn’t this then betting on the core competency that the author initially disagreed in developing). eg:- Maytag, which offered only a few appliances expanded by mergers to offer everything and their returns went from 8% to less than 1% over a span of 10 years.

How to grow?

The goal is to extend strategy to other things that you already perform. That’s basically you are deepening a strategic position than broadening and compromising it. Identify activities and features that are less costly to implement because of complementary activities that they already perform rather than adding new things which the company has noting new to offer as value to customers. Invest more in those things where you are distinct.

Also, globalization allows growth that’s fits well with the strategy as it opens the larger market for more focused strategy. Unlike broadening domestically, expanding globally is likely to leverage and reinforce a company’s unique position and identity. – This is a super cool observation.

If you are broadening domestically, create stand alone units with its own brand name and tailored activities. – I so believe in this and always have been an advocate. Don’t paint everything red immediately because the parent company’s color is red. Take your time as synergies are so difficult to realize and bring it under the same umbrella when you are really sure about the outcomes.

Operational effectiveness is not strategy

Operational effectiveness is about continuously improving everything you do and do not make any trade-offs. Even if you acquire new things, you keep on improving it with out analyzing if its a proper strategic fit.

Strategy on the other hand is about defining a unique position, making clear trade-offs and tightening the fit. But it doesn’t mean that company should have a static view of competition. It should continuously improve and extend its frontier at the same time try to enhance its uniqueness while strengthening its fit. Don’t get a bunch of things because it’s nice. See if it fits you.

This got me thinking if facebook and whatsapp is in a unholy wedlock? Are they strategic fit? Can facebook extend its business model. But they seem to have got the start right as they have been keep as different entities – no facebook blue over whatsapp green yet. Only time will tell how worthy was that $19 Billion spend.

Michael E Porter’s Five Forces

Understand the five forces to better position your company that is more profitable and less vulnerable to attack.

The industry structure defined by the five forces determines the profitability of an industry regardless of the fact that it may be producing a product or service, is emerging or mature, is regulated or unregulated, is high-tech or manual. And the industry structure should be as much of a concern to a strategist as his or her company’s position.

The five forces are:

1. Threat of new entrants
2. Power of suppliers
3. Power of customers
4. Threat of substitutes
5. Rivalry among competitors

Threat of new Entrants

It’s the threat of new entrants and not the entry itself that holds down the profitability. Lesser barrier to entry, powerful financial position of the potential entrant all contributes to greater threat. It usually takes considerable investment from the incumbent to fight and win.

However, incumbents do have some advantages in the form of barriers to entry categorized into seven as given below.

• Supply-side economics: This is basically economies of scale. Incumbents output in the form of product, advertising etc. might be large driving down the cost per piece and to compete with them, the new comer may have to come big or take cost disadvantage – lesser profit, higher sale price etc.
• Demand-side benefits of scale: The more customers who fancy incumbents product such as apple fans, the greater the barrier for the new entrant to make customers switch and that’ll probably be the case till the new entrant builds up considerable customer base.
• Switching cost: These are fixed cost the customer has to bear. Mostly in terms of hardware, retraining for users and employees, documentation and the like. Mobile phone companies use this tactics to an extent by locking the customers in with the release of new phones. Database and software systems are similar examples.
• Capital requirement: This can be in the form of fixed facilities, inventory cost, customer credit, advertisement; upfront R&D. Advt. & R&D are unrecoverable expenses and the higher the unrecoverable expenses, the harder the entry. But do keep in mind that if the returns from the industry are good, investors will fund it.
• Incumbent advantages independent of size: These can be in the form of established brand identities, preferential access to supplier, best geographical location, fine-tuned production process etc.
• Unequal access to distribution channels: These manifests in the form of shelve space in shops for food items, agent access in case of airlines, displacing existing product from the super market such as getting Costco to sell your product.
• Restrictive government policy: It can be in many forms including licensing requirements, safety and environment regulations, expansive patent rules to protect from imitation, foreign direct investment limitations. Of course it can also be helpful in some cases as in distributing R&D for general good, subsidies, and reserving space for new entrants as in Canadian wireless industry’s case.

 Expected retaliation is no less a threat especially if incumbent is powerful financially & politically, has previously reacted vigorously to new entrant buy cutting prices and public statements and if the new entrant can gain customers only by poaching from incumbent because the growth is slow. Again Canadian wireless industry is a fine example.

Power of Suppliers

Suppliers are powerful whenever buyers cannot play them against each other. They keep most of the profit for themselves. That’s the case when suppliers produce unique products as in the case of pharma companies, when there is no substitute such as pilots union, switching cost are high as in the case of Bloomberg terminals or Charles  river trading software, and generally when the supplier industry is more concentrated – few in numbers – than buyers. Some time they can give the threat of integrating forward and make the product available in the market themselves.

Power of Buyers

Buyers tend to keep all the profit for themselves when they can, especially in cases such as when buying undifferentiated products where there are many suppliers, the product is costly relative to their income such as buying a house or when product features have limited attraction. Buyers can also play suppliers when they are very large volume buyers or when they can threaten to integrate backwards such as beverage companies threatening to do packaging themselves.

Threat of Substitutes

The threat is high when the value it brings to the customer is high and the switching cost is low.

Cheap and reliable automobiles threaten public transport companies. Skype phones threaten land lines. Netflix threaten movie-rental business. Courier & parcel services threaten postal service.

Rivalry among competitors

Rivalry among competitors in the same dimension such as price is more likely to erode profitability. On the other hand, when they compete in different dimension, such as product features, support services, delivery time, it’s less likely to be a zero-sum game as it can potentially provide better value for the customer. And in cases when rivals compete on different customer segments with mixes of prices, service, delivery, features, brand identities etc., it can even be a positive sum game. Competition just on price is probably the worst because it transfers profits directly from an industry to its customers.

How do you analyze the five forces?

Below are some of the questions you can try to answer in order to analyze the five forces.

 Threat of new entrant

You are assumed to be the incumbent here

•  Can the new entrant use its existing capability to shake up your market?
• Do you have low cost per unit that the new entrant would find hard to match?
• Do you already have a large satisfied customer base?
• Does your customer show brand loyalty?
• Is the switching cost for you customer to the new entrant low?
• Does the new entrant need large capital investment to enter your market?
• Do you have tie-ups or preferential access to distribution channels?
• Does the government policy favor you or the new entrant?
• Are you known to respond vigorously to new entrants by price cutting, promotion etc.?
• Do you wield substantial political & financial power to keep your market share?
• Is it a slow growth industry where new entrant has to poach your customer for business?

 Power of Suppliers

You are assumed to be the buyer here

•  Is the supplier industry more concentrated?  (Few suppliers and many buyers)
• Does the supplier serve many industries? (No one in particular is important)
• Are you a large volume buyer for the supplier? (Especially in high fixed cost industry)
• Is the cost of switching from one supplier to another high?
• Are there substitutes for supplier available?
• Does the supplier offer differentiated product to you?
• Can the supplier integrate forward and produce your stuff?
• Can you integrate backward and produce suppliers stuff?

Power of Customers

You are assumed to be the supplier here

•  Are there many buyers or just few?
• Do you have any large volume buyers (especially if you are in high fixed cost industry)?
• Is your product standardized or undifferentiated?
• Is the switching cost high for the buyers?
• Can the buyer integrate backward and produce your stuff by themselves?
• Can you integrate forward and produce the buyers stuff?
• Are they “price” sensitive?

Is the product expensive relative to income? (More price sensitive if yes)
Is the buyer strapped for cash? (More price sensitive if yes)
Is the quality of whatever the buyer does affected by your product? (Less pricing sensitive if it is)
Will your product earn big returns for the buyer in the future? (Less sensitive if it can earn big returns)

Threat of Substitutes

•  How does the substitute fare against you in terms of price-features-performance trade-off? The better the relative value of the substitute, greater the threat.
• Does the buyer have high cost of switching to substitute?

Rivalry among competitors

• Are there many players of equal size and power in the market? Poaching will be rampant when there are many players.
• Is it a slow growth industry? Vigorous fight for market share if it’s a slow growth industry
• Are the rivals highly committed to business with goals going beyond economic performance?
• Is there a price war already?

Do the rivals compete in the same segment?
Are the products and services nearly identical in the same segment?
Are the fixed cost high and marginal costs low?
Do they have to expand capacity in large increments to be efficient?
Is the product perishable? (Food, computer software/hardware)

Factor look-alikes – Forces

Now, there are certain factors that can be mistaken for factors and may look like they have a direct impact on profitability. However, their influence is only through their impact on the five forces. Most common are, industry growth rate, government, complementary products and services. Complementary products for example make substitution difficult reducing the threat from substitution. Gasoline powered automobiles have enough easily accessible gas stations throughout the country unlike electric automobiles.

Factors for strategic planning

You have a company. Now where do you stand in terms to rivals, customers, suppliers, substitutes and new entrants? Understanding the five factors and analyzing the industry will help you develop the strategy to position your company, exploit industry change, shape the industry structure and define the industry.

Position your company: This is about finding a spot where the forces are the weakest. An understanding of the forces also helps with identifying opportunities and to decide on entering or exiting the market.

Exploiting industry change: This is about sniffing opportunities in the changing industry landscape for exploitation to the company’s advantage. Itunes exploited the reluctance of music labels to board on each other’s platform when music was getting more into digital format by providing a common platform to sell music to large customer base.

Shaping new industry: Rather than responding to the changing industry as in the case of exploiting, you can shape the industry structure itself by altering the five forces for the better and thus transforming the industry once and for all. While everyone in the industry benefits from it, you can benefit the most by shifting the industry into a spot where you can excel.

You do that by

Re-dividing profitability; where in you divide the pie in favor of existing incumbent instead of handing over to suppliers, customer, new entrants and substitutes. You try to understand the factors constraining the profit and address them effectively plugging the leak to suppliers, buyers, substitutes and new entrants.

A few ways of doing it:

Established Rivals: Differentiate your product to thwart competition
Fickle Customers: Expand your service making it harder for the customers to leave unless they are willing to compromise.
Suppliers: Standardize your parts so that many players can supply what you need.
New Players: Driving up the fixed cost for competing to thwart new entrants.
Substitutes: Offer better value through new features and wider product accessibility.

 Expanding the profit pool, where in everyone benefits because the overall productivity level and processes of the industry improves. This is basically a win-win opportunity for all.

In sum, a strategist who looks beyond his company to understand the factors that impact the industry structure would be better positioned for long time survival and profitability of the company.