Good Strategy Bad Strategy by Richard Rumelt

How strongly I recommend this book: 8 / 10

Date read: April 24, 2022

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Summary

Richard Rumelt’s book is a classic on strategy. Every good strategy, according to Rumelt, has a kernel —

“A good strategy has an essential logical structure that I call the kernel. The kernel of a strategy contains three elements: a diagnosis, a guiding policy, and coherent action.”

This book is covered with a plethora of examples where organizations failed at their strategy, and where some excelled. I’ve written a detailed summary in my newsletter here, but you can check out key highlights below.

Favorite Quotes and Chapter Notes

I went through my notes and progressively capture key quotes from all chapters below.

P.S. – Highly recommend Readwise if you want to get the most out of your reading.

Introduction - Overwhelming Obstacles

Good strategy almost always looks this simple and obvious and does not take a thick deck of PowerPoint slides to explain.
A talented leader identifies the one or two critical issues in the situation—the pivot points that can multiply the effectiveness of effort—and then focuses and concentrates action and resources on them. Despite the roar of voices wanting to equate strategy with ambition, leadership,“vision,” planning, or the economic logic of competition, strategy is none of these. The core of strategy work is always the same: discovering the critical factors in a situation and designing a way of coordinating and focusing actions to deal with those factors. A leader’s most important responsibility is identifying the biggest challenges to forward progress and devising a coherent approach to overcoming them.
A good strategy honestly acknowledges the challenges being faced and provides an approach to overcoming them. And the greater the challenge, the more a good strategy focuses and coordinates efforts to achieve a powerful competitive punch or problem-solving effect.
Bad strategy tends to skip over pesky details such as problems. It ignores the power of choice and focus, trying instead to accommodate a multitude of conflicting demands and interests.
Strategy cannot be a useful concept if it is a synonym for success. Nor can it be a useful tool if it is confused with ambition, determination, inspirational leadership, and innovation. Ambition is drive and zeal to excel. Determination is commitment and grit. Innovation is the discovery and engineering of new ways to do things. Inspirational leadership motivates people to sacrifice for their own and the common good.1 And strategy, responsive to innovation and ambition, selects the path, identifying how, why, and where leadership and determination are to be applied.
Many people assume that a strategy is a big-picture overall direction, divorced from any specific action. But defining strategy as broad concepts, thereby leaving out action, creates a wide chasm between“strategy” and“implementation.” If you accept this chasm, most strategy work becomes wheel spinning.
A good strategy includes a set of coherent actions. They are not“implementation” details; they are the punch in the strategy. A strategy that fails to define a variety of plausible and feasible immediate actions is missing a critical component.
Executives who complain about“execution” problems have usually confused strategy with goal setting. When the“strategy” process is basically a game of setting performance goals—so much market share and so much profit, so many students graduating high school, so many visitors to the museum—then there remains a yawning gap between these ambitions and action. Strategy is about how an organization will move forward. Doing strategy is figuring out how to advance the organization’s interests. Of course, a leader can set goals and delegate to others the job of figuring out what to do. But that is not strategy. If that is how the organization runs, let’s skip the spin and be honest—call it goal setting.
A good strategy has an essential logical structure that I call the kernel. The kernel of a strategy contains three elements: a diagnosis, a guiding policy, and coherent action. The guiding policy specifies the approach to dealing with the obstacles called out in the diagnosis. It is like a signpost, marking the direction forward but not defining the details of the trip. Coherent actions are feasible coordinated policies, resource commitments, and actions designed to carry out the guiding policy.
For example, looking at the U.S. government’s“strategy” for dealing with the 2008 financial crisis, you will see that essential elements are missing. In particular, there was no official diagnosis of the underlying malady. So, there can be no focus of resources and actions on a cure. There has only been a shift of resources from the public to the banks. You do not need a PhD in macroeconomics to make this judgment—it follows from understanding the nature of good strategy itself.
Bad strategy is more than just the absence of good strategy. Bad strategy has a life and logic of its own, a false edifice built on mistaken foundations. Bad strategy may actively avoid analyzing obstacles because a leader believes that negative thoughts get in the way. Leaders may create bad strategy by mistakenly treating strategy work as an exercise in goal setting rather than problem solving. Or they may avoid hard choices because they do not wish to offend anyone—generating a bad strategy that tries to cover all the bases rather than focus resources and actions.
Our education system is rich with targets and standards, but poor in comprehending and countering the sources of underperformance. The only remedy is for us to demand more from those who lead. More than charisma and vision, we must demand good strategy.

Part I Good and Bad Strategy

The most basic idea of strategy is the application of strength against weakness. Or, if you prefer, strength applied to the most promising opportunity.
The standard modern treatment of strategy has expanded this idea into a rich discussion of potential strengths, today called“advantages.” There are advantages due to being a first mover: scale, scope, network effects, reputation, patents, brands, and hundreds more. None of these are logically wrong, and each can be important. Yet this whole midlevel framework misses two huge, incredibly important natural sources of strength:
1. Having a coherent strategy—one that coordinates policies and actions. A good strategy doesn’t just draw on existing strength; it creates strength through the coherence of its design. Most organizations of any size don’t do this. Rather, they pursue multiple objectives that are unconnected with one another or, worse, that conflict with one another.
2. The creation of new strengths through subtle shifts in viewpoint. An insightful reframing of a competitive situation can create whole new patterns of advantage and weakness. The most powerful strategies arise from such game-changing insights.
The first natural advantage of good strategy arises because other organizations often don’t have one. And because they don’t expect you to have one, either. A good strategy has coherence, coordinating actions, policies, and resources so as to accomplish an important end. Many organizations, most of the time, don’t have this. Instead, they have multiple goals and initiatives that symbolize progress, but no coherent approach to accomplishing that progress other than“spend more and try harder.” APPLE
The power of Jobs’s strategy came from directly tackling the fundamental problem with a focused and coordinated set of actions. He did not announce ambitious revenue or profit goals; he did not indulge in messianic visions of the future. And he did not just cut in a blind ax-wielding frenzy—he redesigned the whole business logic around a simplified product line sold through a limited set of outlets.
He did not attack my argument. He didn’t agree with it, either. He just smiled and said,“I am going to wait for the next big thing.” Jobs did not enunciate some simple-minded growth or market share goal. He did not pretend that pushing on various levers would somehow magically restore Apple to market leadership in personal computers. Instead, he was actually focused on the sources of and barriers to success in his industry—recognizing the next window of opportunity, the next set of forces he could harness to his advantage, and then having the quickness and cleverness to pounce on it quickly like a perfect predator.
Good strategy requires leaders who are willing and able to say no to a wide variety of actions and interests. Strategy is at least as much about what an organization does not do as it is about what it does.
The second natural advantage of many good strategies comes from insight into new sources of strength and weakness. Looking at things from a different or fresh perspective can reveal new realms of advantage and opportunity as well as weakness and threat.
Half of what alert participants learn in a strategy exercise is to consider the competition even when no one tells you to do it in advance. Looking just at the actions of a winning firm, you see only part of the picture. Whenever an organization succeeds greatly, there is also, at the same time, either blocked or failed competition.
Their insight was framed in the language of business strategy: identify your strengths and weaknesses, assess the opportunities and risks(your opponent’s strengths and weaknesses), and build on your strengths.
To detect a bad strategy, look for one or more of its four major hallmarks:
- Fluff. Fluff is a form of gibberish masquerading as strategic concepts or arguments. It uses“Sunday” words(words that are inflated and unnecessarily abstruse) and apparently esoteric concepts to create the illusion of high-level thinking.
- Failure to face the challenge. Bad strategy fails to recognize or define the challenge. When you cannot define the challenge, you cannot evaluate a strategy or improve it.
- Mistaking goals for strategy. Many bad strategies are just statements of desire rather than plans for overcoming obstacles.
- Bad strategic objectives. A strategic objective is set by a leader as a means to an end. Strategic objectives are“bad” when they fail to address critical issues or when they are impracticable.
Bad strategy, I explained, is not the same thing as no strategy or strategy that fails rather than succeeds. Rather, it is an identifiable way of thinking and writing about strategy that has, unfortunately, been gaining ground. Bad strategy is long on goals and short on policy or action. It assumes that goals are all you need. It puts forward strategic objectives that are incoherent and, sometimes, totally impracticable. It uses high-sounding words and phrases to hide these failings.

FLUFF

Fluff is superficial restatement of the obvious combined with a generous sprinkling of buzzwords. Fluff masquerades as expertise, thought, and analysis.
FAILURE TO FACE THE PROBLEM A strategy is a way through a difficulty, an approach to overcoming an obstacle, a response to a challenge. If the challenge is not defined, it is difficult or impossible to assess the quality of the strategy. And if you cannot assess a strategy’s quality, you cannot reject a bad strategy or improve a good one.
DARPA’s surprising strategy has a shape and structure common to all good strategy. It follows from a careful definition of the challenge. It anticipates the real-world difficulties to be overcome. It eschews fluff. It creates policies that concentrate resources and actions on surmounting those difficulties.
A strategy is like a lever that magnifies force.
Motivation is an essential part of life and success, and a leader may justly ask for“one last push,” but the leader’s job is more than that. The job of the leader is also to create the conditions that will make that push effective, to have a strategy worthy of the effort called upon.
Business leaders know their organizations should have a strategy. Yet many express frustration with the whole process of strategic planning. The reason for this dissatisfaction is that most corporate strategic plans are simply three-year or five-year rolling budgets combined with market share projections. Calling a rolling budget of this type a“strategic plan” gives people false expectations that the exercise will somehow result in a coherent strategy.
To obtain higher performance, leaders must identify the critical obstacles to forward progress and then develop a coherent approach to overcoming them.
The leader’s responsibility is to decide which of these pathways will be the most fruitful and design a way to marshal the organization’s knowledge, resources, and energy to that end. Importantly, opportunities, challenges, and changes don’t come along in nice annual packages. The need for true strategy work is episodic, not necessarily annual.

BAD STRATEGIC OBJECTIVES

One of the challenges of being a leader is mastering this shift from having others define your goals to being the architect of the organization’s purposes and objectives.
Dog’s Dinner Objectives Good strategy works by focusing energy and resources on one, or a very few, pivotal objectives whose accomplishment will lead to a cascade of favorable outcomes. One form of bad strategic objectives occurs when there is a scrambled mess of things to accomplish—a“dog’s dinner” of strategic objectives.
Blue-Sky Objectives The second form of bad strategic objectives is one that is“blue sky.” A good strategy defines a critical challenge. What is more, it builds a bridge between that challenge and action, between desire and immediate objectives that lie within grasp. Thus, the objectives a good strategy sets should stand a good chance of being accomplished, given existing resources and competence.(See the discussion of proximate objectives in chapter 7.) By contrast, a blue-sky objective is usually a simple restatement of the desired state of affairs or of the challenge. It skips over the annoying fact that no one has a clue as to how to get there.
When a leader characterizes the challenge as underperformance, it sets the stage for bad strategy. Underperformance is a result. The true challenges are the reasons for the underperformance. Unless leadership offers a theory of why things haven’t worked in the past, or why the challenge is difficult, it is hard to generate good strategy.
Not miscalculation, bad strategy is the active avoidance of the hard work of crafting a good strategy. One common reason for choosing avoidance is the pain or difficulty of choice.
A second pathway to bad strategy is the siren song of template-style strategy—filling in the blanks with vision, mission, values, and strategies.
A third pathway to bad strategy is New Thought—the belief that all you need to succeed is a positive mental attitude.

THE UNWILLINGNESS OR INABILITY TO CHOOSE

The essential difficulty in creating strategy is not logical; it is choice itself. Strategy does not eliminate scarcity and its consequence—the necessity of choice. Strategy is scarcity’s child and to have a strategy, rather than vague aspirations, is to choose one path and eschew others. There is difficult psychological, political, and organizational work in saying“no” to whole worlds of hopes, dreams, and aspirations. When a strategy works, we tend to remember what was accomplished, not the possibilities that were painfully set aside.
Strategies focus resources, energy, and attention on some objectives rather than others. Unless collective ruin is imminent, a change in strategy will make some people worse off. Hence, there will be powerful forces opposed to almost any change in strategy.
When organizations are unable to make new strategies—when people evade the work of choosing among different paths into the future—then you get vague mom-and-apple-pie goals that everyone can agree on. Such goals are direct evidence of leadership’s insufficient will or political power to make or enforce hard choices. Put differently, universal buy-in usually signals the absence of choice.

TEMPLATE-STYLE STRATEGY

Leadership and strategy may be joined in the same person, but they are not the same thing. Leadership inspires and motivates self-sacrifice. Change, for example, requires painful adjustments, and good leadership helps people feel more positively about making those adjustments. Strategy is the craft of figuring out which purposes are both worth pursuing and capable of being accomplished.
To achieve great ends, charisma and visionary leadership must almost always be joined with a careful attention to obstacles and action, as Gandhi was able to do in India. There, his carefully orchestrated demonstrations, marches, publicity, and times in jail built his base and eroded the British rulers’ self-image of fairness and morality. His charisma and vision, coupled with a good strategy, gave India both independence and a proud heritage.
Yes, Welch thought formal strategic planning was a waste of time, but he also said,“The first step of making strategy real is figuring out the big ‘aha’ to gain sustainable competitive advantage—in other words, a significant, meaningful insight about how to win.”
Nevertheless, the doctrine that one can impose one’s visions and desires on the world by the force of thought alone retains a powerful appeal to many people. Its acceptance displaces critical thinking and good strategy.
Good strategy is coherent action backed up by an argument, an effective mixture of thought and action with a basic underlying structure I call the kernel.
**The kernel of a strategy contains three elements:
1. A diagnosis that defines or explains the nature of the challenge. A good diagnosis simplifies the often overwhelming complexity of reality by identifying certain aspects of the situation as critical.
2. A guiding policy for dealing with the challenge. This is an overall approach chosen to cope with or overcome the obstacles identified in the diagnosis.
3. A set of coherent actions that are designed to carry out the guiding policy. These are steps that are coordinated with one another to work together in accomplishing the guiding policy.**
In business, the challenge is usually dealing with change and competition. The first step toward effective strategy is diagnosing the specific structure of the challenge rather than simply naming performance goals. The second step is choosing an overall guiding policy for dealing with the situation that builds on or creates some type of leverage or advantage. The third step is the design of a configuration of actions and resource allocations that implement the chosen guiding policy.
The core content of a strategy is a diagnosis of the situation at hand, the creation or identification of a guiding policy for dealing with the critical difficulties, and a set of coherent actions.

THE DIAGNOSIS

A great deal of strategy work is trying to figure out what is going on. Not just deciding what to do, but the more fundamental problem of comprehending the situation.
At a minimum, a diagnosis names or classifies the situation, linking facts into patterns and suggesting that more attention be paid to some issues and less to others. An especially insightful diagnosis can transform one’s view of the situation, bringing a radically different perspective to bear. When a diagnosis classifies the situation as a certain type, it opens access to knowledge about how analogous situations were handled in the past. An explicit diagnosis permits one to evaluate the rest of the strategy. Additionally, making the diagnosis an explicit element of the strategy allows the rest of the strategy to be revisited and changed as circumstances change.
Importantly, none of these diagnoses can be proven to be correct—each is a judgment about which issue is preeminent. Hence, diagnosis is a judgment about the meanings of facts.
The diagnosis for the situation should replace the overwhelming complexity of reality with a simpler story, a story that calls attention to its crucial aspects. This simplified model of reality allows one to make sense of the situation and engage in further problem solving. Furthermore, a good strategic diagnosis does more than explain a situation—it also defines a domain of action. Whereas a social scientist seeks a diagnosis that best predicts outcomes, good strategy tends to be based on the diagnosis promising leverage over outcomes.

THE GUIDING POLICY

The guiding policy outlines an overall approach for overcoming the obstacles highlighted by the diagnosis. It is“guiding” because it channels action in certain directions without defining exactly what shall be done. Kennan’s containment and Gerstner’s drawing on all of IBM’s resources to solve customers’ problems are examples of guiding policies. Like the guardrails on a highway, the guiding policy directs and constrains action without fully defining its content. Good guiding policies are not goals or visions or images of desirable end states. Rather, they define a method of grappling with the situation and ruling out a vast array of possible actions.
You may correctly observe that many other people use the term“strategy” for what I am calling the“guiding policy.” I have found that defining a strategy as just a broad guiding policy is a mistake. Without a diagnosis, one cannot evaluate alternative guiding policies. Without working through to at least the first round of action one cannot be sure that the guiding policy can be implemented. Good strategy is not just“what” you are trying to do. It is also“why” and“how” you are doing it.
A good guiding policy tackles the obstacles identified in the diagnosis by creating or drawing upon sources of advantage. Indeed, the heart of the matter in strategy is usually advantage. Just as a lever uses mechanical advantage to multiply force, strategic advantage multiplies the effectiveness of resources and/or actions. Importantly, not all advantage is competitive. In nonprofit and public policy situations, good strategy creates advantage by magnifying the effects of resources and actions.
A guiding policy creates advantage by anticipating the actions and reactions of others, by reducing the complexity and ambiguity in the situation, by exploiting the leverage inherent in concentrating effort on a pivotal or decisive aspect of the situation, and by creating policies and actions that are coherent, each building on the other rather than canceling one another out.
There was no way to establish that this particular guiding policy was the only good one, or the best one. But, absent a good guiding policy, there is no principle of action to follow. Without a guiding policy, Stephanie’s actions and resource allocations would probably be inconsistent and incoherent, fighting with one another and canceling one another out. Importantly, adopting this guiding policy helped reveal and organize the interactions among the many possible actions.

COHERENT ACTION

Many people call the guiding policy“the strategy” and stop there. This is a mistake. Strategy is about action, about doing something. The kernel of a strategy must contain action. It does not need to point to all the actions that will be taken as events unfold, but there must be enough clarity about action to bring concepts down to earth. To have punch, actions should coordinate and build upon one another, focusing organizational energy.
The INSEAD library holds a bronze statue of Doriot inscribed with his observation“Without action, the world would still be an idea.”
It is the hard craft of strategy to decide which priority shall take precedence. Only then can action be taken. And, interestingly, there is no greater tool for sharpening strategic ideas than the necessity to act.
“Suppose,” I said,“that this was really important, really top-priority critical. Suppose you absolutely had to get some Pan-European products developed and marketed in the next eighteen months or everything would collapse. What would you do then?”
Strategy is primarily about deciding what is truly important and focusing resources and action on that objective. It is a hard discipline because focusing on one thing slights another.
The actions within the kernel of strategy should be coherent. That is, the resource deployments, policies, and maneuvers that are undertaken should be consistent and coordinated. The coordination of action provides the most basic source of leverage or advantage available in strategy.
The idea that coordination, by itself, can be a source of advantage is a very deep principle. It is often underappreciated because people tend to think of coordination in terms of continuing mutual adjustments among agents. Strategic coordination, or coherence, is not ad hoc mutual adjustment. It is coherence imposed on a system by policy and design. More specifically, design is the engineering of fit among parts, specifying how actions and resources will be combined.
Strategy is visible as coordinated action imposed on a system. When I say strategy is“imposed,” I mean just that. It is an exercise in centralized power, used to overcome the natural workings of a system. This coordination is unnatural in the sense that it would not occur without the hand of strategy.
One of the great lessons of the twentieth century—the most dramatic controlled experiment in human history—was that centrally controlled economies are grossly inefficient. More people starved to death in Stalin’s and Mao Tse-tung’s centrally planned regimes than were killed in World War II.
But decentralized decision making cannot do everything. In particular, it may fail when either the costs or benefits of actions are not borne by the decentralized actors. The split between the costs and benefits may occur across organizational units or between the present and the future. And decentralized coordination is difficult when benefits accrue only if decisions are properly coordinated. Of course, centrally designed policies can also fail if the decision makers are foolish, in the pay of special interest groups, or simply choose incorrectly.
As is clear to anyone who has belonged to a coordinating committee, coordination interrupts and de-specializes people. Thus, we should seek coordinated policies only when the gains are very large. There will be costs to demanding coordination, because it will ride roughshod over economies of specialization and more nuanced local responses.
Good strategy and good organization lie in specializing on the right activities and imposing only the essential amount of coordination.

Part II Sources of Power

A“good strategy” is an approach that magnifies the effectiveness of actions by finding and using sources of power.
A good strategy draws power from focusing minds, energy, and action. That focus, channeled at the right moment onto a pivotal objective, can produce a cascade of favorable outcomes. I call this source of power leverage.
Strategic leverage arises from a mixture of anticipation, insight into what is most pivotal or critical in a situation, and making a concentrated application of effort.
The strategist may have insight into predictable aspects of others’ behavior that can be turned to advantage.
To achieve leverage, the strategist must have insight into a pivot point that will magnify the effects of focused energy and resources.
Returns to concentration arise when focusing efforts on fewer, or more limited, objectives generates larger payoffs. These gains flow from combinations of constraints and threshold effects. If resources were not limited, there would be no need to select one objective over another. If rivals could easily see our moves and quickly mobilize responses, we would gain little from concentrating on temporary weaknesses.
An important duty of any leader is to absorb a large part of that complexity and ambiguity, passing on to the organization a simpler problem—one that is solvable. Many leaders fail badly at this responsibility, announcing ambitious goals without resolving a good chunk of ambiguity about the specific obstacles to be overcome. To take responsibility is more than a willingness to accept the blame. It is setting proximate objectives and handing the organization a problem it can actually solve.
A system has a chain-link logic when its performance is limited by its weakest subunit, or“link.” When there is a weak link, a chain is not made stronger by strengthening the other links.
When each link is managed somewhat separately, the system can get stuck in a low-effectiveness state. The problem arises because of quality matching.1 That is, if you are in charge of one link of the chain, there is no point in investing resources in making your link better if other link managers are not.
IKEA teaches us that in building sustained strategic advantage, talented leaders seek to create constellations of activities that are chain-linked. This adds extra effectiveness to the strategy and makes competitive imitation difficult.
Most of the work in systems design is figuring out the interactions, or trade-offs, as they were called.
My objectives are not to show my class how to manage a can company, or even how to create a good strategy. Instead, they are(1) to teach them how to identify a company’s strategy,(2) to deepen their skills at analyzing qualitative information, and(3) to explore a particular mixture of policy and positioning called focus.
They will not have noticed that the details of Crown’s policies point in other directions as well. In general, people will not push further because the analysis of unstructured information is hard, time-consuming work that requires both a rich knowledge of facts and well-developed skills in logic, deduction, and induction.
To begin identifying a company’s strategy, it is usually most helpful to examine the competitive environment.
If you are serious about strategy work, you must always do your own analysis. A strategy is not necessarily what the CEO intended or what some executive says it is. Sometimes they are hiding the truth, sometimes they are misstating it, and sometimes they have taken a position as leader without really knowing the reasons for their company’s success.
“If we are not going to automatically accept the opinions of others, how can we independently identify a company’s strategy? We do this by looking at each policy of the company and noticing those that are different from the norm in the industry. We then try to figure out the common target of such distinctive policies—what they are coordinated on accomplishing.”
When faced with a question or problem to which there is no obvious answer, it is human nature to welcome the first seemingly reasonable answer that pops into mind, as if it were a life preserver in a choppy sea. The discipline of analysis is to not stop there, but to test that first insight against the evidence.
This particular pattern—attacking a segment of the market with a business system supplying more value to that segment than the other players can—is called focus. Here, the word“focus” has two meanings. First, it denotes the coordination of policies that produces extra power through their interacting and overlapping effects. Second, it denotes the application of that power to the right target.
The logic of this strategy was not visible in the company’s own self-description, nor in the pronouncements of Wall Street analysts.
“If you do the work, can you find the real strategic logic of every business?”“No,” I reply,“not of every business. If the business is really successful, then there is usually a good strategic logic behind that success, be it hidden or not. But the truth is that many companies, especially large complex companies, don’t really have strategies. At the core, strategy is about focus, and most complex organizations don’t focus their resources. Instead, they pursue multiple goals at once, not concentrating enough resources to achieve a breakthrough in any of them.”
Healthy growth is not engineered. It is the outcome of growing demand for special capabilities or of expanded or extended capabilities. It is the outcome of a firm having superior products and skills. It is the reward for successful innovation, cleverness, efficiency, and creativity. This kind of growth is not just an industry phenomenon. It normally shows up as a gain in market share that is simultaneous with a superior rate of profit.
The secret to using advantage is understanding this particularity. You must press where you have advantages and side-step situations in which you do not. You must exploit your rivals’ weaknesses and avoid leading with your own.
If your business can produce at a lower cost than can competitors, or if it can deliver more perceived value than can competitors, or a mix of the two, then you have a competitive advantage.
For an advantage to be sustained, your competitors must not be able to duplicate it. Or, more precisely, they must not be able to duplicate the resources underlying it. For that you must possess what I term an“isolating mechanism,” such as a patent giving its holder the legally enforceable right to monopolize the use of a technology for a time.2 More complex forms of isolating mechanisms include reputations, commercial and social relationships, network effects,* dramatic economies of scale, and tacit knowledge and skill gained through experience.
Competitive advantage is interesting when one has insights into ways to increase its value. That means there must be things you can do, on your own, to increase its value.
**Despite all the emphasis on“competitive advantage” in the world of business strategy, you cannot expect to make money—to get wealthier—by simply having, owning, buying, or selling a competitive advantage. The truth is that the connection between competitive advantage and wealth is dynamic. That is, wealth increases when competitive advantage increases or when the demand for the resources underlying it increases. In particular, increasing value requires a strategy for progress on at least one of four different fronts:
- deepening advantages,
- broadening the extent of advantages,
- creating higher demand for advantaged products or services, or
- strengthening the isolating mechanisms that block easy replication and imitation by competitors.**

Deepening Advantage

Start by defining advantage in terms of surplus—the gap between buyer value and cost. Deepening an advantage means widening this gap by either increasing value to buyers, reducing costs, or both.
Underlying principle is that improvements come from reexamining the details of how work is done, not just from cost controls or incentives.
Companies that excel at product development and improvement carefully study the attitudes, decisions, and feelings of buyers. They develop a special empathy for customers and anticipate problems before they occur.
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.
The most obvious approach to strengthening isolating mechanisms is to working on stronger patents, brand-name protections, and copyrights.
Another broad approach to strengthening isolating mechanisms is to have a moving target for imitators. In a static setting, rivals will sooner or later figure out how to duplicate much of your proprietary know-how and other specialized resources. However, if you can continually improve, or simply alter, your methods and products, rivals will have a much harder time with imitation.
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 the dynamics play out.
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. 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.

DISCERNING THE FUNDAMENTALS

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 that 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.
It is hard to show your skill as a sailor when there is no wind. Similarly, it is in moments of industry transition that skills at strategy are most valuable. During the relatively stable periods between episodic transitions, 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.
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. If you can peer into the fog of change and see 10 percent more clearly than others see, then you may gain an edge.
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 demarks an industry transition induced by escalating fixed costs. The second calls out a transition created 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.

Guidepost 1 — Rising Fixed Costs

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.

Guidepost 2 — Deregulation

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.
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.

Guidepost 3 — Predictable Biases

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 and 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.
The logic of the situation is counterintuitive to many people—the faster the uptake of a durable product, the sooner the market will be saturated. Many managers find these kinds of forecasts uncomfortable, even disturbing. As a client once told me,“Professor, if you can’t get that bump out of the forecast, I can find a consultant who will.”
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.
A third common bias is that, in a time of transition, the standard advice offered by consultants and other analysts will be to adopt the strategies of those competitors that are currently the largest, the most profitable, or showing the largest rates of stock price appreciation. Or, more simply, they predict that the future winners will be, or will look like, the current apparent winners.

Guidepost 4 — Incumbent Response

Expect incumbent firms to resist a transition that threatens to undermine the complex skills and valuable positions they have accumulated over time.

Guidepost 5 — Attractor States

An industry attractor state describes how the industry“should” work in the light of technological forces and the structure of demand. By saying“should,” I mean to emphasize an evolution in the direction of efficiency—meeting the needs and demands of buyers as efficiently as possible. Having a clear point of view about an industry’s attractor state helps one ride the wave of change with more grace.
Successful strategies often owe a great deal to the inertia and inefficiency of rivals.
An organization’s greatest challenge may not be external threats or opportunities, but instead the effects of entropy and inertia. In such a situation, organizational renewal becomes a priority.

INERTIA

The Inertia of Routine
Inertia due to obsolete or inappropriate routines can be fixed. The barriers are the perceptions of top management. If senior leaders become convinced that new routines are essential, change can be quick. The standard instruments are hiring managers from firms using better methods, acquiring a firm with superior methods, using consultants, or simply redesigning the firm’s routines.
The Inertia of Culture
The hard-won lesson was that a good product-market strategy is useless if important competencies, assumed present, are absent and their development is blocked by long-established culture.
The first step in breaking organizational culture inertia is simplification. This helps to eliminate the complex routines, processes, and hidden bargains among units that mask waste and inefficiency. Strip out excess layers of administration and halt nonessential operations—sell them off, close them down, spin them off, or outsource the services. Coordinating committees and a myriad of complex initiatives need to be disbanded. The simpler structure will begin to illuminate obsolete units, inefficiency, and simple bad behavior that was hidden from sight by complex overlays of administration and self-interest.
After the first round of simplification, it may be necessary to fragment the operating units. This will be the case when units do not need to work in close coordination—when they are basically separable. Such fragmentation breaks political coalitions, cuts the comfort of cross-subsidies, and exposes a larger number of smaller units to leadership’s scrutiny of their operations and performance. After this round of fragmentation, and more simplification, it is necessary to perform a triage. Some units will be closed, some will be repaired, and some will form the nuclei of a new structure. The triage must be based on both performance and culture—you cannot afford to have a high-performing unit with a terrible culture infect the others. The“repair” third of the triaged units must then be put through individual transformation and renewal maneuvers.
In general, to change the group’s norms, the alpha member must be replaced by someone who expresses different norms and values. All this is speeded along if a challenging goal is set. The purpose of the challenge is not performance per se, but building new work habits and routines within the unit.
Inertia by proxy disappears when the organization decides that adapting to changed circumstances is more important than hanging on to old profit streams.
Entropy is a great boon to management and strategy consultants. Despite all the high-level concepts consultants advertise, the bread and butter of every consultant’s business is undoing entropy—cleaning up the debris and weeds that grow in every organizational garden.
Whenever a company succeeds greatly there is a complementary story of impeded competitive response. Sometimes the impediment is the innovator’s patent or similar protection, but more often it is an unwillingness or inability to replicate the innovator’s policies.

Part III Thinking like a strategist

A new strategy is, in the language of science, a hypothesis, and its implementation is an experiment. As results appear, good leaders learn more about what does and doesn’t work and adjust their strategies accordingly.
STRATEGY IS A HYPOTHESIS
The problem of coming up with a good strategy has the same logical structure as the problem of coming up with a good scientific hypothesis. The key differences are that most scientific knowledge is broadly shared, whereas you are working with accumulated wisdom about your business and your industry that is unlike anyone else’s.
In a changing world, a good strategy must have an entrepreneurial component. That is, it must embody some ideas or insights into new combinations of resources for dealing with new risks and opportunities.
To generate a strategy, one must put aside the comfort and security of pure deduction and launch into the murkier waters of induction, analogy, judgment, and insight.
One of the most important resources a business can have is valuable privileged information—that is, knowing something that others do not. There is nothing arcane or illicit about such information—it is generated every day in every operating business. All alert businesspeople can know more about their own customers, their own products, and their own production technology than anyone else in the world. Thus, once Schultz initiated business operations, he began to accumulate privileged information.
The idea that people have goals and automatically chase after them like some kind of homing missile is plain wrong. The human mind is finite, its cognitive resources limited. Attention, like a flashlight beam, illuminates one subject only to darken another. When we attend to one set of issues, we lose sight of another.
A CEO, locked in competition with another bidder for a company, can lose track of the broader reasons for the acquisition.
Being strategic is being less myopic—less shortsighted—than others. You must perceive and take into account what others do not, be they colleagues or rivals. Being less myopic is not the same as pretending you can see the future. You must work with the facts on the ground, not the vague outlines of the distant future. Whether it is insight into industry structures and trends, anticipating the actions and reactions of competitors, insight into your own competencies and resources, or stretching your own thinking to cover more of the bases and resist your own biases, being“strategic” largely means being less myopic than your undeliberative self.
I say,“But, you do not have to be a captive to that unconscious dodge. You can choose how you will approach a problem; you can guide your own thinking about it.” I want them to see that this is the heart of the matter. This personal skill is more important than any one so-called strategy concept, tool, matrix, or analytical framework. It is the ability to think about your own thinking, to make judgments about your own judgments.
In strategy work, knowledge is necessary but not sufficient. There are many people with deep knowledge or experience who are poor at strategy. To guide your own thinking in strategy work, you must cultivate three essential skills or habits. First, you must have a variety of tools for fighting your own myopia and for guiding your own attention. Second, you must develop the ability to question your own judgment. If your reasoning cannot withstand a vigorous attack, your strategy cannot be expected to stand in the face of real competition. Third, you must cultivate the habit of making and recording judgments so that you can improve.
The kernel is a list reminding us that a good strategy has, at a minimum, three essential components: a diagnosis of the situation, the choice of an overall guiding policy, and the design of coherent action.
When one has an initial insight into what to do about a challenging situation, it never occurs in the form of a full-blown strategy. Rather, the lightning of insight strikes in one of the three elements of the kernel. It may be an insight into action, as in the case of the participant who wanted to put smaller disk drives in TiVo machines. It may be an insight into a general directive, as it was for the participant who wanted to shift focus to the cable TV segment. Or insight may arrive in the form of a diagnosis, as in the case of the participant who saw TiVo as the consumer’s friend but also as a Napster-like thorn in the side of the industry.
What the kernel does, however, is remind us that a strategy is more than a localized insight. It is an internally consistent argument that leads from facts on the ground to diagnosis, thence to an overall directive, thence to action. The kernel reminds us to expand the scope of our thinking to include all three elements.
Many attempts at strategy lack a good diagnosis. Hence, it is useful to have mental tools for working backward from a guiding policy to the realm of diagnosis and fact. There is nothing deep about this process other than realizing that it can and should be done.
People normally think of strategy in terms of action—a strategy is what an organization does. But strategy also embodies an approach to overcoming some difficulty. Identifying the difficulties and obstacles will give you a much clearer picture of the pattern of existing and possible strategies. Even more important, you will gain access to how changes in some factors may radically alter the mix of efficacious strategies. To gain this change in perspective, shift your attention from what is being done to why it is being done, from the directions chosen to the problems that these choices address.
The creation of new higher-quality alternatives requires that one try hard to“destroy” any existing alternatives, exposing their fault lines and internal contradictions. I call this discipline create-destroy.
Trying to destroy your own ideas is not easy or pleasant. It takes mental toughness to pick apart one’s own insights. In my own case, I rely on outside help—I invoke a virtual panel of experts that I carry around in my mind. This panel of experts is a collection of people whose judgments I value. I use an internal mental dialogue with them to both critique my own ideas and stimulate new ones. I try to do this before putting my ideas before others. The panel of experts trick works because we are adept at recognizing and comprehending well-integrated human personalities. Thinking through how a particular well-remembered expert might respond to a problem can be a richer source of criticism and advice than abstract theories or frameworks. My own personal virtual panel of experts contains respected executives I have known and worked with, people who educated and trained me, colleagues I have worked with over the years, and certain people whose points of view emerge clearly from their own written work or from biography. When I face a problem, or have generated a first hunch, I turn to this panel and ask,“What is wrong with this approach to the situation? What would you do in this case?”
Jobs’s basic operating principles have become the stuff of legend:(1) imagine a product that is“insanely great,”(2) assemble a small team of the very best engineers and designers in the world,(3) make the product visually stunning and easy to use, pouring innovation into the user interface,(4) tell the world how cool and trendy the product is with innovative advertising.
That we are the entrepreneurial school.”“That’s interesting,” said Jobs.“Which Silicon Valley entrepreneurs have come out of your program that I would recognize?” Jack grimaced, then answered truthfully,“There aren’t any.”“Well, then, you’ve failed,” Jobs said with finality. That day, he became part of my mental panel of experts.
Listening to Teece’s and Jobs’s imaginary counsel, I am reminded that good strategies are usually“corner solutions.” That is, they emphasize focus over compromise. They focus on one aspect of the situation, not trying to be all things to all people.
Learning from others can be more than simply listening to them, watching them, or reading what they write. When you build your own panel of experts you go one step farther, trying to shape your understanding of their teachings into a virtual personality. When it works, it does so because we humans have built-in software for understanding other humans, software that is more expert at recognizing and recalling personalities than at almost anything else.
In business and politics, and in many aspects of military strategy, most of the important judgments are about people, especially anticipating their actions and reactions.
Good judgment is hard to define and harder still to acquire. Certainly some part of good judgment seems to be innate, connected with having a balanced character and an understanding of other people. Still, I am convinced that judgment can be improved with practice. For that practice to be effective, you should first commit your judgments to writing.
What this student has missed is the opportunity to pre-commit to a position and thereby subsequently evaluate her own judgment. To commit to a judgment is to choose an interpretation of which issues are critical and which are not and then to choose an implied action. By committing to a judgment—especially a diagnosis—you increase the probability that you will disagree with some of the assessments of others, and thereby increase the chance of learning something.
The introductory topic taught in any modern course on business strategy is the connection between industry structure and profit. This topic is usually called the“Five Forces,” following Michael Porter’s pioneering analysis of industry structure, published in 1980. A quick summary is that a terrible industry looks like this: the product is an undifferentiated commodity; everyone has the same costs and access to the same technology; and buyers are price sensitive, knowledgeable, and willing to switch suppliers at a moment’s notice to get a better deal.
The collapse of prices could have been foreseen by anyone doing a simple Five Forces analysis. Why was this analysis ignored? Because the stock market promised something better.
An important virtue of a good leader is putting the situation in perspective and having cool-minded judgment. Both virtues help mitigate the bias inherent in social herding and the inside view. The inside view describes the fact that people tend to see themselves, their group, their project, their company, or their nation as special and different. Thus, for example, many people are aware of today’s outside-view statistic that talking on a cell phone while driving increases your accident risk by a factor of five—about the same as being drunk. But the inside view of the situation is“I am a good driver; those statistics don’t apply to me.” Similarly, we know that although most new restaurants fail, each entrepreneur thinks his or her new restaurant is different.
Social herding presses us to think that everything is OK(or not OK) because everyone else is saying so. The inside view presses us to ignore the lessons of other times and other places, believing that our company, our nation, our new venture, or our era is different. It is important to push back against these biases. You can do this by paying attention to real-world data that refutes the echo-chamber chanting of the crowd—and by learning the lessons taught by history and by other people in other places.