Strategy Innovation and the Quest for Value

Profound change in the competitive environment has produced a Cambrian explosion of new organizational forms, institutional relationships, and value-creating possibilities. Schumpeter’s gale has become a hurricane. Whether you call it the “digital” economy, the “knowledge” economy, or just the “new” economy, it seems clear that we are on the cusp of an industrial revolution as profound as that which gave birth to the modern age. But, of course, we already know this. We’ve all read Alvin Toffler, Nicholas Negroponte, and Wired. The deeper question is, who will profit from this sea change? Which companies will sail on the new winds of change and which will be driven onto the rocks of irrelevance? I believe that only those companies that are capable of reinventing themselves and their industry in a profound way will be around a decade hence. The question today is not whether you can reengineer your processes; the question is whether you can reinvent the entire industry model — as Amazon.com has been attempting to do in book selling, as Enron has done in the energy business, or as (TC)2 hopes to do in the clothing industry.

In industry after industry, it is the revolutionaries — usually newcomers — who are creating the new wealth. Of course, there are examples of incumbents like Coca-Cola and Procter & Gamble that are able to continually reinvent themselves and their industry, but all too often, industry incumbents fail to challenge their own orthodoxies and succumb to unconventional rivals.

The point seems incontestable: in a discontinuous world, strategy innovation is the key to wealth creation. Strategy innovation is the capacity to reconceive the existing industry model in ways that create new value for customers, wrong-foot competitors, and produce new wealth for all stakeholders.1 Strategy innovation is the only way for newcomers to succeed in the face of enormous resource disadvantages, and the only way for incumbents to renew their lease on success. And if one redefines the metric of corporate success as share of new wealth creation within some broad opportunity domain — e.g., energy, transportation, communication, computing, and so on — the innovation imperative becomes inescapable.

Today, many companies are worrying about EVA (economic value added), but EVA — earning more than your cost of capital — is just the starting point. The goal is not to earn more than your cost of capital; the goal is to capture a disproportionate share of industry wealth creation. There are many semiconductor companies that earn more than their cost of capital, but it is Intel that has created and captured much of the new value in the microprocessor industry during the past decade. Of course Intel earns its cost of capital, but it earns much more than that.

One way of measuring share of wealth creation is to compare a company’s current share of the total market capitalization of all firms in a particular competitive domain with its share of market capitalization ten years earlier. For example, at Strategos, we have calculated that, in 1988, IBM’s share of total market capitalization within the computing and office equipment domain amounted to 45.9 percent. By 1997, this figure had fallen to 14.2 percent. During the same period, DEC’s share fell from 10.3 percent to 1.1 percent. Microsoft’s share soared from zero to 22.7 percent. If IBM had maintained its share, it would be worth approximately $140 billion more than its current value. When, in the late 1980s and early 1990s, IBM unwittingly surrendered its historic role as the architect of industry transformation, it also surrendered billions of dollars in future wealth creation.

Kmart, a pioneer in discount retailing, saw its share of total wealth within the retailing domain plummet from 8.2 percent in 1988 to 2.8 percent in early 1997. Wal-Mart’s share surged from 19.2 percent to 28.1 percent during the same decade. While IBM, Kmart, and other tarnished leaders may be able to prop up the price of their shares through massive stock repurchases, they are unlikely to create fundamentally new wealth unless they regain their capacity for strategy innovation.

Shareholders love strategy innovation. Again, let’s look at the evidence. Between 1985 and 1995, there were fewer than forty companies of the Fortune 1,000 that grew total shareholder returns by more than 25 percent per annum. This is the most exclusive club in U.S. industry. These companies averaged a compounded annual growth in revenues of 25.3 percent during this time frame, while operating margins improved at a rate of just 6.7 percent per year. Given these growth rates, revenues will increase by almost ten times during a decade, while margins will nearly double. So, if the goal is to dramatically improve shareholder returns, where is the leverage going to come from? Clearly, it will come from revenue growth, not from improvement in operating margins. Most companies are simply running out of headroom on margin improvement.

Twenty-five percent revenue growth, less than 7 percent margin growth — that’s a ratio of 3.5 to 1. But how many managers, during the past few years, have put 3.5 times the amount of effort into revenue growth that they invested in margin improvement? The obsession of most senior managers has been cost reduction, not growth.

But hold on, I am not suggesting that growth is the antidote to the pain wrought by downsizing and reengineering. There is always a tendency to mistake the scoreboard for the game. Growth is the score-board, but it is definitely not the game. Focusing on growth, rather than on the game of strategy innovation, is likely to destroy wealth rather than create it. The reason is simple. There are as many stupid ways to grow as there are to cut: acquisitions that destroy value (Sony and Matsushita in Hollywood), market share battles that lower industry profitability (the airlines’ perennial favorite), and megabucks blue-sky projects (think Apple and the Newton) are just a few examples that should illustrate the danger of go-for-broke growth strategies. Needless to say, companies pursuing value-destroying growth won’t make it onto any list of star performers.

When we dig deeper, we find that those extraordinarily successful companies that managed 25 percent-plus growth rates in shareholder returns grew by radically changing the basis for competition in their industries. They either invented totally new industries or dramatically reinvented existing ones. This is true for Home Depot, Amgen, Nike, Intel, Compaq, the Gap, and most of the other companies on the super-star list. They all developed nonlinear strategies.

Is Strategy Irrelevant?

So if strategy innovation is key to creating new wealth, why is “strategy” no longer a “big idea” in most companies? Why does it seem to command so little of top management’s time and attention? And why are planners an increasingly endangered species?

It has been at least ten years since strategy was the brightest star in the firmament of management ideas. It was the work of Bruce Henderson and the Boston Consulting Group, as well as the PIMS research project, that pushed strategy’s star above the managerial horizon in the mid-1970s — this and General Electric’s pioneering use of planning within its “strategic business units.” With the publication of Michael Porter’s profoundly insightful book, Competitive Strategy, in 1980, strategy’s star rose farther still.

But by the mid-1980s, the strategy star was beginning to dim, as managers turned their attention to quality, cycle time reduction, and the other operational improvement challenges foisted on them by global competitors and impatient shareholders. Strategy’s star was finally eclipsed in 1993, with the publication of Michael Hammer and James Champy’s Reengineering the Corporation. Big thinking was out, euphemisms for downsizing were in.

Many consulting companies that had been designing corporate futures in the 1980s suddenly found themselves two levels down in their clients’ companies, grinding away at the coal face of operational inefficiency or slicing away at layers of bureaucratic flab. Consultants became masters of corporate liposuction. Their revenues were up, but fewer and fewer of their minions could claim to be working on big strategy problems or to be helping their clients invent the future.

The competitive environment faced by companies today is far, far different from that which gave birth to the concept of strategy some thirty years ago. But, while the rapidly shifting strategy environment has partially devalued some traditional strategy concepts, such as industry structure analysis, it has also provided the impetus for much new thinking. Indeed, the changing context for strategy has provoked a huge amount of new thinking on the content of strategy. The new themes in the strategy world include: foresight, knowledge, competencies, coalitions, networks, extra-market competition, ecosystems, transformation, renewal. All these subjects are intensely contemporary.

So strategists certainly can’t be accused of being ignorant of the new competitive realities. But as informed as they may be, impactful they are not. Why? Because managers simply do not know what to do with all the wonderful concepts, frameworks, and buzzwords that tumble from the pages of the Harvard Business Review, that jam the business aisles of bookstores, and that glisten in the slickly edited pages of business magazines.

Strategists may have a lot to say about the context and content of strategy, but, in recent years, they have had precious little to say about the conduct of strategy — that is, the task of strategy making. No one seems to know much about how to create strategy. Managers today know how to embed quality disciplines, how to reengineer processes, and how to reduce cycle times, but they don’t know how to foster the development of innovative wealth-creating strategies.

So, while there has been enormous innovation around the content of strategy — management has an ever-expanding list of “strategic” issues to address — there has been no corresponding innovation around the conduct of strategy. Let’s face it, the annual strategic planning process in most companies has changed hardly at all during the past decade or two.

It’s ironic; never has a capacity for deep strategic thinking been so necessary as in today’s turbulent times, and yet never, in the past two decades, has strategy’s “share of voice” been lower in the corridors of corporate power. Some argue that the tide is turning. In summer 1996, Business Week ran a cover story proclaiming that “strategic planning is back.”2 But the tide has not changed; there are just a few hopeful souls swimming against the flow.

For the tide to turn, the practice of strategy must be reinvented. Sorry, did I say reinvented? Let’s not pretend. There’s little that’s worth reinventing. Surely, we’re not going to start with the traditional planning process in our quest to increase the value added of strategy! No, we must start from scratch. The challenge is to invent anew the conduct of strategy in ways that make it intensely important to companies struggling to maintain their vitality in the innovate-or-die environment of the new economy.

What Are the Secrets of Strategy Creation?

The strategy industry — all those consultants, business school professors, authors, and planners — has a dirty little secret. Everyone knows a strategy when they see one — be it Microsoft’s, Nucor’s, or Virgin Atlantic’s. We all recognize a great strategy after the fact. In the case study method, professors hold strategies up to be admired, or ridiculed, by preternaturally wise MBA students. Their post hoc explanations of the competitive success and failure that ensue are stunningly beautiful. We are great at pinning down butterflies. But our case libraries and business magazines, with their stories of corporate success and failure, are museums filled with dead specimens. Simply put, we all know strategy as a “thing” — once someone else has bagged it and tagged it. We also understand planning as a “process.” But the planning process doesn’t produce strategy, it produces plans — a point that Henry Mintzberg has made on more than one occasion.

Anyone who claims to be a strategist should be intensely embarrassed by the fact that the strategy industry doesn’t have a theory of strategy creation! It doesn’t know where bold, new value-creating strategies come from. There’s a gaping hole in the middle of the strategy discipline. No, let me put that differently: there’s no foundation to the strategy discipline. I mean, really! Maybe a general manager hungry for a new strategy should eat a fiery vindaloo curry at eleven o’clock at night and hope that, when the inevitable indigestion interrupts his or her slumber, it succeeds in provoking a strategy insight. Gastric upset is at least as likely to produce a strategy insight as attendance at another interminable planning review.

What we need is a deep theory of strategy creation. Think about the amount of progress that has been made during the past fifteen years on the content of strategy: competitive rivalry, the resource-based view of the firm, hypercompetition, coalitions, knowledge management, etc. Now ask, how much progress has been made on the practice of strategy? Or compare the rate of innovation during the past twenty years in how companies develop products, manage the supply chain, or build quality into products with the rate of innovation in how they do strategy. Case closed.

The questions we must address are these: How can we create a Cambrian explosion of innovative strategies inside the firm? What does it take to invent new strategy “S curves”? To answer these questions, we must have a theory of strategy innovation. Developing such a theory is a grand project. All I can do here is to offer a few starting propositions.

I agree with Mintzberg that strategy “emerges.” But I don’t believe the emergent nature of strategy creation prevents us from aiding and abetting the process of strategy innovation. We are not helpless. The reason I don’t believe we’re helpless is because strategy doesn’t simply emerge — rather, it is emergent, in the same full-bodied sense that life itself is emergent. One of the things we’re learning from complexity theorists is that by creating the right set of preconditions, one can provoke emergence. Stuart Kauffman, a pioneer in complexity theory, has suggested that life began with an “autocatalytic” system — a self-reinforcing set of chemical reactions.3 Whether you agree or disagree, the analogy may be useful. What, we must ask, would catalyze the emergence of new, viable strategies in a successful, though complacent, organization? My guess is that the answer, while perhaps subtle, will nevertheless be easier to come by than the mystery of life.

Once you start thinking of strategy as an emergent phenomenon, you realize that we have often attacked the wrong end of the problem. Strategists and senior executives have too often worked on “the strategy,” rather than on the preconditions that could give rise to strategy innovation. In essence, they’ve been trying to design complex, multicell organisms, rather than trying to understand and create the conditions from which such organisms will emerge.

So we must start with a search for the deep rules of emergence. I think the fundamental challenge is to discover, and make explicit, the linkages between:

The rules of strategy emergence ? strategy innovation ? industry revolution ? the creation of new wealth.

Emergence is not a random walk; neither, it has been suggested, was biological evolution. There are many who now believe that if evolution had been an entirely random process, we would still be amoebas. It is asserted that the time frame of life on earth has been too short for blind experimentation to get us to our present stage of biological order. Life evolved toward order, as do all emergent systems.4

Two great forces of nature seem to be counterposed. On one hand, there is the general trend toward entropy. When we convert fossil fuel into heat, to power our cars or heat our homes, we are turning highly ordered energy — complex carbon molecules — into “disordered” energy — heat, as well as a variety of pollutants. These things can never be “put back together.” The second law of thermodynamics suggests that we are sliding inevitably toward chaos. Not only does the law characterize physical systems, it often seems to characterize human systems. Many organizations seem to be affected by a kind of “institutional entropy” in which energy, enthusiasm, and effectiveness slowly dissipate over time.

Yet we see order all around us: the New York Stock Exchange, Toyota’s supplier network, a great university, or, most miraculous of all, ourselves. A human being is an almost infinitely more ordered thing, and a much, much more complex system, than a single-celled organism. Order seems to be the second great force in nature. And while entropy may be inevitable in physical systems, there is nothing to suggest that it is inevitable in biological or human systems. Of course, perfect order is never achieved; disruptive change always intervenes. Nevertheless, the impulse for order is everywhere visible in the world around us — with the notable exception of a teenager’s bedroom!

While a complex living system, and the order it possesses, is probably not the product of random variation, neither can it be designed top-down. The New York Stock Exchange couldn’t be designed top-down. Neither could life on the Internet, nor a human being, nor a complex but internally consistent strategy. What is going on in all these cases is what Kauffman calls “order without careful crafting.” “Order without careful crafting” — I’d like to suggest that this is the goal of strategizing.

Order arises from simple, deep rules. Craig Reynolds has shown that with three simple rules, one can richly simulate the behavior of a flock of birds in flight.5 So it’s not that there is no crafting, no design, only that it works at the level of preconditions and broad parameters — not at the level of a detailed design. So while there was a simple architecture underlying the Internet, no one could have envisioned all the rich permutations of Net-based life that would emerge in the new on-line biosphere. Likewise, while there was a simple, overarching intent to the U.S. space program in the 1960s, the strategies for getting a human to the moon were deeply emergent.

Like all forms of complexity, strategy is poised on the border between perfect order and total chaos, between absolute efficiency and blind experimentation, between autocracy and complete ad hocracy. Now if you believe even some of this, it has profound implications for how we think about strategy — and where we should focus our attention if the goal is to develop a capacity for strategy innovation deep within organizations. Let me illustrate with this old story of how humans acquired a taste for cooked meat. One day, a wild pig wandered into a hut; lightening struck the hut; the hut burned down; a human poked through the charred remains, touched the pig, sucked on a finger, and voila! Yummy (at least, for carnivores).

Business school researchers from the “process school” of strategy, along with business journalists, have expended much effort in studying the “accidents” of strategy making. Process researchers pick through the ashes; “So this is how an idea fights its way up through a sclerotic organization over months or years and finally succeeds in changing the company’s strategy.” “Wow, what a great story!” remarks the journalist. But maybe we could do something to make the path from insight to strategy less arduous. Maybe we could dramatically improve the odds of an insight occurring and then being translated into purposeful action. Maybe those who study the complicated, emergent nature of strategy creation can be more than mere reporters.

On the other hand, researchers in the “content school” (Michael Porter, first and foremost) have given all would-be pig eaters a set of elaborate criteria to determine whether or not they really have a pig, versus something much less palatable. “Will this particular strategy make money?,” is the question here. Strategy professors and consultants have produced elaborate guides to pig spotting but typically know little about pig farming and much less about the culinary arts required to turn that pig into terrine de rillettes. Industrial economists and traditional consultants are not strategy chefs.

For their part, planners assure everyone that, with the right incantations, you can get lightning to strike twice in the same place. Ultimately, after much trial and error, humankind discovered the principles of cooking and the oven. Later came the principles of animal husbandry. Human beings still cannot make a pig out of nothing — only a pig can make a pig — but they have learned how to construct a system that dramatically increases the probability of getting pork on the plate on any given night of the week.

Let me ask a question of those who’ve ever sat through a business school case study: Have you ever gotten halfway through a brilliant exposition of a company’s strategy and thought to yourself, “Did they really have this thing figured out ahead of time? Isn’t this just luck? Isn’t this 20/20 hindsight? What about all the failures?” Sure, you have. These impertinent questions lie at the heart of our search for a theory of strategy creation. Is a great strategy luck, or is it foresight? Of course, the answer is that it is both. Circumstance, cognition, data, and desire converge, and a strategy insight is born. The fact that strategy has a significant element of serendipity to it shouldn’t cause us to despair. The alternatives are not the “big brain” design school of strategy, nor the “muddle along” process school. The question is, how can we increase the odds that new wealth-creating strategies emerge? How can we make serendipity happen? How can we prompt emergence?

How Does Strategy Emerge?

The most fundamental insight of complexity theory is that “complex behavior need not have complex roots,” as Christopher Langton has so succinctly put it.6 So what are the simple roots of strategy creation? My experience, and that of my colleagues at Strategos, in helping companies improve their capacity for strategizing suggests that there are five preconditions for the emergence of strategy. (Vindaloo curry is not on the list.)

1. New voices. Bringing new “genetic material” into the strategy process always serves to illuminate unconventional strategies. Top management must give up its monopoly on strategy creation, and previously underrepresented constituencies must be given a larger share of voice in the strategy creation process. Specifically, I believe that young people, newcomers, and those at the geographic periphery of the organization deserve a larger share of voice. It is in these constituencies where diversity lurks. So strategy creation must be a pluralistic process, a deeply participative undertaking.
2. New conversations. Creating a dialogue about strategy that cuts across all the usual organizational and industry boundaries substantially increases the odds that new strategy insights will emerge. All too often, in large organizations, conversations become hard-wired over time, with the same people talking to the same people about the same issues year after year. After a while, individuals have little left to learn from each other. Opportunities for new insights are created when one juxtaposes previously isolated knowledge in new ways.

3. New passions. Unleashing the deep sense of discovery that resides in almost every human being, and focusing that sense of discovery on the search for new wealth-creating strategies is another prerequisite. I believe the widespread assumption that individuals are against change is flat wrong. People are against change when it doesn’t offer the prospect of new opportunity. There is much talk today about return on investment, but I like to think in terms of return on emotional investment. Individuals will not invest emotionally in a firm and its success unless they believe they will get a return on that investment. All my experience suggests that individuals will eagerly embrace change when given the chance to have a share of voice in inventing the future of their company. They will invest when there’s a chance to create a unique and exciting future in which they can share.
4. New perspectives. New conceptual lenses that allow individuals to reconceive their industry, their company’s capabilities, customer needs, and so on substantially aid the process of strategy innovation. To increase the probability of strategy innovation, managers must become the merchants of new perspective. They must search constantly for new lenses that help companies reconceive themselves, their customers, their competitors, and, thereby, their opportunities.
5. New experiments. Launching a series of small, risk-avoiding experiments in the market serves to maximize a company’s rate of learning about just which new strategies will work and which won’t. The insights that come from a broad-based strategy dialogue will never be perfect. While much traditional analysis can be done to refine those insights into viable strategies, there is much that can be learned only in the marketplace.

So where does this leave us? We should spend less time working on strategy as a “thing” and more time working to understand the preconditions that give rise to the “thing.” Executives, consultants, and business school professors must rebalance the attention given to context, content, and conduct in favor of conduct. In focusing on the conduct of strategy, not only are we trying to discover something — the hidden properties of strategy emergence — we are also trying to invent something. Like those long-ago Neanderthals trying to figure out the principles of cooking (“Why can’t we have pork every night, rather than only after electrical storms?”), we need to invent an oven — a strategy oven.

In our quest for the strategy oven, our most valuable insights will probably come from far beyond the traditional strategy disciplines. Personally, I believe we will discover the strategy oven at the juncture of concepts like emergence, self-organization, cognition, and organizational learning. Science is closing in on the deep secrets of life. And we, as strategists, are finally beginning to close in on the deep secrets of corporate vitality.

Words to the Wise

For those of you who, like me, have found employment within the strategy industry, I have a final comment.

To Professors.

If you’re a strategy professor and you want to have a role in inventing the strategy oven, you’d better roll up your sleeves and get involved in the world of practice. You can no longer be a mere observer. You must create laboratories, inside real institutions, where you can study the phenomenon of emergence. Like particle physicists, strategy researchers must develop their hypotheses, build their particle accelerators, and then see if their musings about the deep structures of strategy creation really are valid. We must do more than merely study strategy emergence; we must become active experimenters in the realm of strategy creation.

I have long admired Peter Senge’s approach to action research with the MIT Center for Organizational Learning. Through Senge’s work, thousands of “application labs” (my term, not his) have been built in companies around the world. From these laboratories, learning about learning emerges. Where is the strategy field’s equivalent set of social experiments? I’m not suggesting that strategy professors become consultants. I am suggesting that they stop being dilettantes.

To Consultants.

If you’re a traditional strategy consultant, watch out. If I’m a senior executive, why should I pay your twenty-nine-year-old to teach me about my industry? Wouldn’t it be better to get my own twenty-nine-year-olds, and everybody else in my company, to help teach me about the future? So stop trying to create dependency and start trying to embed a deep capability for strategy innovation. Work to put yourselves out of business!

To Planners.

Unless you get involved in the quest for the deep secrets of strategy emergence, the best you can hope for is honorable mention in a Dilbert cartoon.