Why your strategy needs bold moves, not just bold forecasts
February 21, 2018 – Mark Twain beautifully summarized the typical problem with bold forecasts when he said, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”
There is a lot of “we know for sure” around. During presentations, I sometimes ask how many people in the room believe that the Great Wall of China is the only man-made object visible from space. Most end up raising their hands. They know it to be true—except it isn’t. The claim, first made in 1754, was disproved in 1961 when the first cosmonaut, Yuri Gagarin, orbited the Earth. He was unable to pick out the Great Wall with his naked eye, and no space traveler since then has either, because the wall is made from rock that is indistinguishable from the surrounding terrain.
Similar firmly held misconceptions, beliefs and behavioral quirks often trip up the strategy process. Perhaps the biggest pitfall is the human propensity for bold forecasts and timid actions, a tendency Nobel-winning economist Daniel Kahneman first identified 25 years ago. We want to see exceptional growth in sales, earnings, and other metrics, but won’t make the big investments needed to generate those results.
Here are some of the leading culprits behind failed forecasts.
The lack of a proper baseline
During the first Internet boom, one of my clients considered investing $1 billion in a new fiber-optic cable network across the U.S., based on the estimates of explosive growth in communication. But that seemingly unlimited demand wasn’t the full picture. There was already a lot of fiber in use, and its capacity increased as the routers that dispatch signals improved. Combined with yet-unused installed lines and the announced plans of competitors, the fiber capacity would exceed even the most outrageous demand projections for the coming years. Because the company took the time to do a proper baseline analysis and saw that what everybody “knew” just did not translate into a smart investment, it decided to stop the project and saved itself from a potentially massive blunder.
Another frequent problem with baselines is planning for market-share gains. In the early days of the personal computer, every electronics company worth its silicon decided it could capture 20% of the rapidly expanding market, ignoring how many others were staking that same claim. Eight companies tried for a 20% share, the industry hopelessly overbuilt, and the shakeout was painful.
Errors in performance attribution
Mistakes in assessing business momentum are also easy to make. Often, performance is mistaken for capability. “We’ve done well, so we must be better than our competition and will continue to prosper”—even though external conditions may have contributed to the success. These types of momentum mistakes are harder to spot when you’re doing well, because the need to understand the underlying dynamics feels less urgent. If a company is thriving in an environment where it can raise prices rapidly, for instance, it may convince itself that it is becoming ever more efficient in its sales operations, simply because the costs of sales are outpaced by revenue growth. When the pricing environment stiffens, however, management may discover all kinds of inefficiencies had crept into the system.
We are prone to attribution errors even when they hurt us (my colleague Chris Bradley summed up by some of the most egregious biases and social dynamics in a recent blog). We all cherish, for instance, the “friendly” family doctor. However, patients of doctors who are in the top quartile for customer satisfaction are associated with 9% higher medical costs and 25% higher mortality rates. A doctor who makes you feel good can put you in danger—but try telling that to a happy patient.
Corporate peanut butter
A few years ago, a McKinsey study showed that more than 90% of budgets at the business unit level are statistically explained by the previous years’ budget levels. In other words, most companies evolve in incremental steps as a result of cautious plans. When it comes to making decisions that have implications for our families, careers, or wealth, we tend to be risk-averse. You might have participated in surveys your bank is obliged to conduct to determine your investor profile. The result of these surveys, along with many experiments by behavioral scientists, show that most of us are much more willing to forgo a large upside to avoid a small downside that the other way around.
When that individual risk aversion gets projected onto corporate strategy, we hit problems. A large, diversified corporation with many investors, themselves diversified, can tolerate a far greater risk tolerance than the middle manager who is the gatekeeper to the plans. You can often see this avoidance of the downside at almost all costs in the strategy room. Big moves are rarely proposed, and even less frequently accepted. How often you have seen a business unit manager come into the annual planning cycle with a strong M&A strategy? Most strategy discussions are about intensifying efforts to gain a few percentage points of market share or to squeeze out a few more points of margin. That will show progress. Nobody will get fired.
Avoiding conflicts on the team, being “practical” about the business, giving every team member a “fair chance,” keeping the motivation up—all these arguments contribute to resource stickiness. Resources end up spread thinly across the company, like peanut butter on your bread.
The other end of the business calendar—the time when incentives, bonuses, and promotions are decided—is another reason for timid plans. The head of operations for a large high-tech industrial company told me recently, “We were beaten up badly earlier this year for missing a target. I’m not going to risk that again.” To boost our odds of success, most of us will vastly prefer a P90 plan (one that we will hit with a 90% chance) over a P50 plan (which we would succeed only 50% of the times). Yet, when we ask CEOs what they consider fair in terms of missed targets, many say that every three to four years a leader should miss a plan if the plan has been stretched enough. What a difference in perspective!
With all the timidity baked into our nature and into the process, committing to a bold plan is exceedingly hard. Yet, as I will explain in future blogs, bold moves are the only way that companies can outperform the market.
This article originally appeared on McKinsey & Company – Strategy & Corporate Finance Blog
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