Is your growth strategy your worst enemy

8/7/2019 Is your growth strategy your worst enemy

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Is your growth strategy your worst enemy?

The brilliance of a strategy may lie in overcoming

powerful secondary effects.

MAY 1995 JOSEPH A. AVILA, NATHANIEL J. MASS, AND MARK P. TURCHAN

y Were sorry, exhibits are not available forthis article.Achieving sustainable growthis a perennialconcern forseniormanagers. Yetthe strategiesthey pursue often capture few ornone oftheintended benefits. Theirefforts arerewardedwith outright failure orwith short-lived wins followed byrapid deterioration. Considerthesecases ofthwarted initiatives:

y Growing too fast. Historyis littered withcompanies thatexperience "boom and bust":rapid growth followed by steep decline, often into oblivion. In the UKlifeinsuranceindustry, London Life pursued an aggressive salesforce growth strategythat putit outofbusiness by 1987. Its hiring practices had set off a vicious spiral of falling skilllevels, flagging motivation, and sinking performance.

y Too muchtoo soon. A polymercompany spotted an attractive, fast-growing marketand invested heavilyin new plant and equipmentto meet demand. Fourrival suppliersresponded by dropping theirprices. Thoughthecompany succeeded in achieving alarge share, eroding margins madethe market unprofitable.

y From glitterto glut. A leading high-techcompany saw first-month orders forits latestproductexceed capacityby 30 percent, and gotits suppliers to increasetheirrawcomponent stocks. Two months later, as stockpiles built up, orders collapsed,precipitating a huge "sludge" inventory. The productended up being branded a dud. Ittranspired that much ofthe original demand consisted of "phantom orders" placed bydistributors concerned about short supplies. Tightinitialcapacityhad actuallyboostedearly demand.

y A fixthat failed. Manycompanies pursue growthby attempting to improvecustomersatisfaction, often through stafftraining and skillbuilding. One automotive OEMrequired its dealers to increasetechnician training, but saw littleimprovementineitherservice performance orcustomersatisfaction. Ithad not foreseen thattechnicians would reactto theirextra training by spending less timein fault diagnosis,orthat dealers funding thetraining would cutback on theirinvestmentin tools and

equipment.y Unintended consequences. These frustrating patterns occurin nationaleconomies too.

In the United States, the 1990 luxurytax was intended to generate an extra $76million in annualrevenues, butit actuallyyielded only $13 million. Thereason: theluxury market forplanes, boats, and automobiles dried up overnight afterthetax wasintroduced.

Why do plans thatlook good on papergo bad when they areexecuted?


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Why do plans thatlook good on papergo bad when they areexecuted? The problem oftenlies in what mightbecalled secondaryeffectsunforeseen by-products of strategythat

confound its originalintentions. The growth strategy ofthe polymercompany, forinstance,took no account ofhow competitors mightreact. Thecompany won the volumeit sought, but

its profits were diminished because of actions byrivals threatened byits new capacity.

Webelievethatcompanies wishing to implement a successful and sustainable growthstrategy need a betterapproachonethattakes account oftheimpact ofthese secondaryeffects and helps managers make moreinformed choices abouthow to accomplishtheirobjectives.

Achieving sustainable growth

To understand these secondaryeffects, itis necessaryto take a dynamic view ofthemarketplaceonethat anticipates competitivereactions and explicitlyincorporates them intostrategy. An analyticaltechniquecalled Business Dynamics has proven especially valuableinthis context. Derived from system dynamics, it applies ideas aboutengineering controlfeedbackto business and economic systems. Itis based on six fundamental guiding principles

(seetheboxed insert).

In thecases below, a Business Dynamics perspectivehelps to explain how sustainable growthwas achieved in two very differentbusinesses.

Service satisfaction in the auto industry

Forautomotive OEMs, repurchaseloyaltywhathappens when existing customers return to

theircurrent auto makerto purchasetheirnext vehicle is worth many millions of dollars.As thequality and functionality of most vehicles approach parity, sales and service aregrowing in importance.

Several auto makers have decided thatimproving customersatisfaction with service atdealerships would raiserepurchaseloyalty. Theyhavelavished vast sums and considerablemanagement attention on training and technical support programsbut detected nonoticeableimpact. Whathas been going wrong?

The OEMsefforts havecertainly notbeen misdirected. Analysis ofcustomersurvey datareveals that satisfaction with service accounts forone-third oftotalcustomersatisfaction, and

is predominantly driven bythe abilityto repaira vehiclecorrectly, on time, and atthe firstattempt. Average dealerperformance againstthis targetis 65 percentmeaning that onein

threecustomers would need to go back forfurtherrepairs. "Bestin class" performance,however, approaches 90 percent, so thereis ampleroom forimprovement.

A fix that failed

Thetraditional solution to this performance shortfall was to establish a policy of mandatorytraining to maketechnicians moreeffective. Butextra training meantthey spentless time atwork. Exacerbated by flat-ratecompensation that favored throughputratherthan quality ofservice, pressure mounted at dealerships. The diagnostic stage oftherepairprocess was oftenrushed, leading to failureto detect faults and thus defeating the object ofthetraining.


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In addition, rising training costs and forgonerevenues ateinto dealers profits, promptingthem to reducetheirinvestmentin tools and equipment, therebylimiting technicians overall

effectiveness.

OEM strategies concerning the use of advanced diagnosticequipment were also vitiated byunanticipated secondaryeffects. Oneextremelycostly device designed to improve diagnostic

accuracyhad a verylow usagerate, despitebeing considered technically superb. Thereasonforits neglect was the fifteen minutes orso thatittookto setit uptimethat pressuredtechnicians felttheycould ill afford to spend. Moreover, a lack ofinitialtraining producedlow familiarity, reinforcing underutilization whichin turn reinforced low familiarity.

One OEM decided thatin orderto improve performance, it needed to identify wherebottlenecks were occurring, and why. It applied Business Dynamics to modeltherepairperformance of an actual dealership. Ittested a scenario involving several new initiatives ithad devised to fixthe service problem byenhancing training and building technical anddiagnostic support. The modeled initiatives produced someimprovements, butthey werelimited and short-lived.

Disappointing results can bereversed by addressing the powerful secondaryeffects inherentin the system

Analyzing the modelrevealed thatthese disappointing results could bereversed byaddressing the powerful secondaryeffects inherentin the system. Incentives to diagnosethereal underlying problem with a vehicle were weak, since pay structures encouragedtechnicians to completejobs as quickly as possible. In addition, initialimprovements in theservice process tended to getcaught up atexisting bottlenecks, sometimes even making themworse. Service advisers became overloaded and less effective;increased retail demand,generated bybettershort-term performance, compounded time pressures and promptedtechnician shortcuts; and new technicians hired to meet demand diluted the averagelevel ofexperience.

The analysis also showed thatthe OEM supportinitiatives broughtleastbenefitto those whoneeded them the mostthelow-performing dealers. Therate ofimprovement forthesedealers was a mere 4 percentage points, whereas theirhigh-performing counterparts achievedan 11-pointleap. Thus the aspiration to improve "fix-it-right" performanceto 85 to 90percent was still waybeyond reach (Exhibit 1).

Clearly, putting morebusiness through a poorly managed system of processes and incentivesyielded little netbenefitto OEM, dealer, orcustomer. Modeling these dynamics revealed thatthe primarybottlenecks layin dealerprocesses. No conceivableimprovementin support fromhead officecould workif dealers responded to highervolumebycutting back diagnosis and

training.

Finding the right fix

Armed withtheseinsights, the OEM is developing a series of dealerprocess initiatives thatshould bring about sustainableimprovements in repairaccuracy. Theimpact ofthis newapproachhas alreadybeen profound. First, ithas revealed thatindividual dealers need theirown tailored solutions; no single approach suits allcases. Second, ithas shown that a well-designed portfolio of process improvements, coupled with OEM support, could raisethe


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average dealertoward an 85 percent fix-it-right score, and atthe sametimeenhancethe netpresent value ofthe dealerfranchiseby around 35 percent. In short, all stakeholders should

benefit.

Understanding the system at workin auto servicing should also permitthe OEM to tap potentreinforcing benefits: betterrepairperformance should lead to higherservice volume, greater

repurchaseloyalty, strengthened profitability, and increased dealerresources to reinvestinthe drivers ofcustomersatisfaction. In addition, OEM programs should becomeeven moreeffective once dealers improvetheirown processes. This combined approachis proving sopowerfulthatrolling it out across theentire dealership network should createbillions ofdollars of shareholderwealth.

Thelesson forthe OEM was that working on a set of functional strategies in isolation wouldnotyield expected benefits

Thelesson forthe OEM was that working on a set of functional strategies in isolation wouldnotyield expected benefits. Instead, it needed to couplethese strategies with actions in other

parts ofthebusiness system to reinforcetheimpact ofthe functionalimprovements and limit

theextent of anycounteracting effects.

Building market share in life insurance

A case study from a differentindustry provides an equally vivid illustration ofthe waysunexpected secondaryeffects can sabotage growth strategies.

In theearly 1970s, two UKlifeinsurancecompanies, Equitable Life and London Life,enjoyed almostidenticalcompetitive positions. Theyeven shared a largecustomerincommon, a university pension fund. In 1975, when it withdrew its business, bothinsurerssuffered a setback. With similaropportunities and challenges, they subsequently followeddiverging paths.

London Life grew rapidly fora while, butbecame virtuallyinsolvent afterthe 1987 stockmarketcrash, and had to berescued via an acquisition. Equitable Life, bycontrast, becameone ofthe most profitablecompanies in this market. Theircontrasting stories highlighttherole of management strategyin determining success orfailure, and demonstratehow BusinessDynamics can reveal opportunities and pitfalls thatconventional strategicthinking oftenmisses.

Different destinies

Aftertheloss ofthe university pension fund, London Life stuckto its corebusiness, rapidlyexpanding its salesforcein orderto createeconomies of scale. Equitable Life, on the otherhand, enforced a policy of putting new hires through morethan a month oftraining to buildskills oriented toward high-end business, and actuallyreduced its back-office staffin linewith a slow, low-cost growth strategy.

Itis notimmediately obvious whythis approach proved superior;indeed, it defiesconventionalindustry wisdom, whichholds thatlarge salesforces are needed to build anylifebusiness. Two of Equitable Lifes distinguishing featureshigh averagecase size (the annualpremium perpolicy sold by an agent) and an agentcommission structure (a driverofinitial


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expenseratio)thatroseless than proportionatelyto policy salesarerated as low inimportancein a standard statistical model ofthelifeinsurancebusiness. However, a dynamic

analysis oftheindustryidentifies these factors as decisive strengths (Exhibit 2).

In reality, the positive, reinforcing benefits ofhighercase sizes amplified Equitable Lifessuccess. Bettercompensation boosted salesforce motivation, stimulated productivity, and

pushed sales and compensation stillhigher. Atthe sametime, well-paid salespeople stayedwiththecompanylonger, raising skilllevels and yielding fewerpolicies that were "orphaned"when the original sales agentleftthecompany. Improved customerretention then reinforcedthecycle ofrising compensation and superiorstaffretention (Exhibit 3). Thebenefitscompounded one anotherin a virtuous spiral ofimprovements.

Thechallengeto find a sustainable growthrate means striking a balancebetween growthdrivers and constraints

Anotherfactorthat shaped the fate ofthetwo companies was theirgrowth aspirations. Forany management, thechallengeis to find a sustainable growthratethat maximizes company

value. This means striking a balancebetween growth drivers, such as skilllevels and case

size, and growthconstraints, such as back-office overload and limited coaching capacity.According to ourcause and effect model ofthebusiness, London Lifes sustainable growthrate was around 12 percentnothing likethe 40 percentexpansion that actuallytook placeinthe salesforce.

Grow slowly

Too rapid a growthrate destroys valuein a numberof ways. Limited coaching capacityinhibits skill development, forinstance, so that sales-

force productivity stalls. Similarly, an overload in theback office diverts salespeopletoadministrativetasks, dampening sales effectiveness. Theresultis a downward spiral:shrinking compensation, salesforce defections, lowercustomerretention, flagging sales, andfalling net worth.

Ifthis is so obvious, why doesnt managementcatch on and do something aboutit? Onereason is thatthehigh-growth strategy does seem to workfora while (see Exhibit 4). Fastergrowth, up to 24 percent a year, raises insurance premium revenues. Productivity declines alittlebut fast growthcan bebumpy. ForLondon Life, thebump ithitreflected Wall Streetsadagethatbankruptcyis the markets way oftelling you to slow down.

Some analysts view London Lifes downfall differently. Theyhold thatits risky securityportfolio madeit vulnerablein the 1987 stock marketcrash. Butif werun a model ofthe

industrythatturns backtheclock and replays events without a stock marketcrash, LondonLife stillcollapsesjust a yearlater. Thecompany was already severely wounded byitsfailed management policies. Indeed, its fate was sealed as early as 1983, when fallingproductivity and net worth were alreadyentrenched.

Likethe auto servicecase, London Lifes story shows whathappens when the secondaryeffects of a growth strategy areignored. So how can seniormanagers factorin theseeffects intheirstrategicthinking? Ourexperience suggests thattwo levels ofinsight are necessary.First, managers need to be alertto what wehavetermed "strategic pitfalls"generic sources


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of failure. Second, they need to be ableto apply dynamic analysis to theirbusiness togenerate specific actionable strategies.

Minimizing secondary effects

In orderto create value-generating growth, companies musttakecareto minimize

undesirable secondaryeffects so as to maximizetheimpact oftheirstrategicinitiatives. Usingthese potential pitfalls as "sanitychecks" on proposed actions can stimulate deeperstrategicthinking and pay offin increased profits.

Strategic portfolio-related pitfalls

The firstconcern ofthe CEO should be strategic portfolio-related pitfalls, since failing hereislethal, no matterhow strong is downstream strategy orexecution:

y An imbalancein growth drivers and bottlenecks destroys value. London Lifesexperiencereveals theimportance of understanding boththe forces that drive growthand thosethatconstrain it. Thoughthecompanys strategy was based on expanding its

corebusiness, unforeseen bottlenecks produced bytoo rapid growthbroughtit almostto extinction.

y Overloaded initiatives reducethroughput. If an organizations developmentcapabilities are stretched in too many directions, not only will fewerproducts orservices belaunched, buttimeto market will grow longer. Withlongerdevelopmentcycles, furtherdelays in product orservicelaunches can occurwhen design changeshaveto be madein mid-stream to keep up withrising markettargets.

y Worsening results triggerstill more fixes. Iftaxincreases are notyielding desiredrevenues, orserviceinitiatives improving customersatisfaction, thetemptation is tointroduceyet moretaxes orinitiatives. CEOs should avoid patching up a sinkingstrategy withevermoreineffectualremedies.

Cross-functional pitfalls

Arising attheinterfaces between day-to-day operations, cross-functional pitfalls can preventgrowthevergetting offthe ground, orrenderinitial gains unsustainable:

y Out-of-sync functional strategies undermine performance. A specialty steel producersuffered chronicallylate deliveries because of uncoordinated actions by variouscorporate departments. Finance squeezed whatit perceived as "excess" inventory;marketing shifted some ofthis stockto export markets atlow margins; operationsreduced the working weekto save money. Theresult: low profits and dissatisfiedcustomers.

y Localincentives push problems around ratherthan solving them. Corporate games ofhot potato can depress growth and profits. At an electric utility, pressured operatorstried to lighten theirworkload by deferring "tagouts"the process of markingequipment dueto betaken offline forrepair. The maintenance department, whichnormallyrequested thesetagouts, responded by using more short-term fixes thatcouldbe made whileequipment was stillrunning. But more frequentrepairs and higherforced outagerates resulted in even morerequests fortagouts, increasing the pressureon operators.


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Localincentives often push problems around, butcorporate games ofhot potato candepress growth and profits

y Simplisticcompliancecan defeat objectives. An industrial goods distributordecreedthatexcess inventory mustbereduced. Local managers responded bycutting easilycontrollable, fast-moving inventoryitems. As shortages emerged, customers started to

marktheirorders "urgent." Theresult: aftera brief decline, surplus inventory soaredhigherthan ever.

y Upstream actions triggerdownstream bottlenecks. The OEM training strategyaggravated problems furtheron in the auto service process: time pressures causingweak diagnosis and poorequipment utilization, forexample. The strategy was notinherentlybad, butit failed to recognize downstream effectsa recipe forhighcostsand low effectiveness.

y Layered bottlenecks frustrate single fixes. Onecomputercompany worried thatlongdelays within its materials resource planning system inhibited responseto customerdemand. Shortening MRP cycles to speed therelease of orders formaterials withlonglead times helped delivery performance, butcreated a new problemmore "sludge"inventory piled up attheend of productlifecycles. Solving onebottleneck simply

brought anotherto light. Like squeezing a balloon, the pressureis transferredelsewhere, butit does not go away.

y Theright strategy needs theright moment. Doing therightthing atthe wrong timecanbe worsethan taking no action at all. In the auto case, improving technician trainingyielded negligiblebenefits in customersatisfaction becausetheincentive system inplace stillrewarded outputquantity overquality. If onlyincentives had beenaddressed beforetraining, this initiative mighthave worked, and customersatisfactionwould haveincreased.

Pitfalls in capabilities and resources

Deep in the guts of operations, yet otherpitfalls surround capabilities and resource allocation:

y Reinforcing capabilities are notin placeto drive growth. Formany organizations,early wins areephemeral, and performance soon stagnates. Onecompanybucked thistrend;its management set ambitious annual goals that pushed itto the outerlimit ofperformance. Theleading-edge understanding ofequipment and process technologyitgained paved the way forfurtherbreakthroughs. Heavyinvestmentin new tools,training, and measurement systems helped thecompany achieve "turbocharged"improvements in volume, costreduction, and profits, with an 8 percent a yearfallinunitcosts atthecompanys leading plant. But such success is hardly an everydaystory; few companies havethe nerveto operate on theedge and staythere. Formost,only a couple ofexperiments haveto failbefore managementreproach nudges the

organization backto its old, safeculture.

Few companies havethe nerveto operate on theedge and staythere

y Withdrawing resources from inefficient processes ultimatelyraisesratherthanlowerscosts. Managers are frequentlytempted to save moneybyreallocatingresources, butthis seldom works unless the processes concerned areimproved atthesametime. In theelectric utilityexample, reducing short-term fixes in the field leadsto morerequests fortagouts, and costs rise.


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y Resourcelimitations set up a spiral of shrinking effectiveness. Say I buy a carbecausemy dealerassures methatthecurrentincentive schemeis aboutto end. Ten days later,

I discoverthatthe program has been not onlyextended, butenhanced. I haveeveryrightto be annoyed. Ifcustomerdissatisfaction becomes widespread, promotions will

falter, leaving a shortfallin auto sales thatthe OEM maytryto make up byintroducing more "sweeteners"the source ofthe discontentin the first place.

Promotional spending then hits budgetlimits and incentive programs arecurtailed tosave money, becoming stillless effective. Sales fall short once more, and thedownward spiral feeds on itself.

Pitfalls in competitive response

Manycompanies payinsufficient attention to possiblecompetitiveresponses to theiractions.Robust strategies recognizethatcompetitors do not stand still. Avoiding the pitfalls meansunderstanding how thecompanies in an industry areconnected and how they mayreacttoone anothers strategic moves:

y Pressured competitors fightto regain position. Oneinternationalchemicalcompanysoughtto expand into the fast-growing Asia Pacific market, building a new plant anda strong regional sales organization. Yeteven as sales rose, worldwide profitabilityfell. The plant was supplying over15 percent ofthe market normally served by NorthAmerican facilities. Perceiving this as a threat, competitors werecutting prices andsqueezing margins, firstin North America, then in Europe and Asia. Worst of all,traditional accounting systems thattrackregional financial performance, but notinteractions between regions, would neverdetectthis cannibalization ofearnings.

y "Boom-bust" behaviorstifles growth. In anotherchemical market, severalcompaniescutcosts by 6 percent a yearforthreeyears in responseto overcapacity and weakprofits. However, they saw 85 percent ofthecostreductions go straightto thecustomeras theirattempts to win market share failed. Low prices triggered capacityshutdowns, but sometimelater, product substitution stimulated demand growth ofover5 percent a year. Within two years, prices were atrecord levels, but producerswerecaughtby surprise withinsufficientcapacityto take advantage oftheboomingmarket.

y Competitive moves underminethebases of profitability. Actions by onecompanycanripplethroughtheindustryto wreckthe very assumptions that originally prompted themove. A majorpetroleum companyinvested in making "clean" products such asgasoline out of "dirty" products such as fuel oil at a time when the differencein pricebetween thetwo was substantial. Within two years, the proliferation ofclean productsand thetightersupply of dirty goods had cutthe price differenceby 50 percent,transforming theexpected profitinto loss. A seniorexecutivelamented: "We made a$1 billion mistake."

Actions by onecompanycan ripplethroughtheindustryto wreckthe veryassumptions that originally prompted the move

Avoiding bottlenecks

Strategies forgrowthcan beblocked bybottlenecks anywherein a business system (Exhibit5). Understanding wherebottlenecks might arise and crafting a strategyto work within or


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around them should be a priority forseniormanagers. A good wayto startis by first mappingoutinterrelationships across thebusiness system, then asking some fundamentalquestions:

y Whatcreates the potential forgrowthin this business? Is it service performance, as inthe auto case, orchoosing theright market and growthrate, as in thelifeinsurancecase, orsome othersource specificto ourindustry?

y What arethe primarybottlenecks thatlimitcurrent growth?y If we address them, which second-levelbottlenecks will surface next? And how do we

deal withthose?y As we put ourgrowth strategies in place, how do werecognize and avoid potential

strategic pitfalls?

Thereis certainly no shortage of ways to fail, but as the OEM and lifeinsurancecasessuggest, understanding business complexity and designing strategies around trueleveragepoints can unleash genuinely profitable growth potential.

The CEO challenge

The Business Dynamics approachto building a betterunderstanding ofthe secondaryeffectsof growth strategies raises fourkeyquestions forCEOs to consider:

1. Underwhatconditions can growthbe sustained in ourindustry?2. How can webuild skills and awareness so that ourpeople will always take account of

secondaryeffects in theirstrategicthinking?3. How can we shapethe structure and incentive systems of ourorganization in line with

theseinsights to minimizethe unintended secondaryeffects of ourgrowth strategyand maximizeits impact?

4. How can we usethis capabilityto strike a more powerful strategicbalancebetweenefficiency measures (such as costreduction) and effectiveness improvements (such ashigherproductivity)?

We are on thethreshold of a new way ofthinking forCEOs that gets atthe answerto thesequestions and helps them bettermanagethe growth oftheirbusinesses. Thecomplexity oftodays competitivelandscapeis shaping a new seniormanagement agenda: developingprofitable, sustainable strategies forgrowth and understanding fullythe dynamic secondaryeffects oftheiractions in pursuit ofthese strategies. Onlythen willbusinesses escapethe

pitfalls thathaveheld them back forso long.

Principles ofBusiness Dynamics

1. Every action produces a reaction. One specific secondaryeffect ofthe new US luxurytax

was unemploymentin theboatbuilding industry. Ittook atleast a yearforthetax authoritiesto appreciatethe fullimpact oftheiractions.

2. Structure shapes behavior. Thelinkages between parts of a business system and the waysin which decisions are made determineits performance. Hencebehaviorcan be modified only

through fundamentalchanges to the structure of a system.


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Is your growth strategy your worst enemy