In his book “Thinking Fast and Slow”, Nobel Laureate Daniel Kahneman described the “inner view” that often arises when we focus only on the current problem. This view leads us to extrapolate from our own experiences and data, even when we want to tackle something new. The “inside view” is also reinforced by excessive self-confidence and other cognitive biases as well as by internal politics.
It is now well known that people are susceptible to a variety of distortions through fear of loss, the urge to confirm or avoid mistakes. While these mental shortcuts help us to filter information in our daily lives, they are not always easy to understand. But they distort our view when we make large, momentous decisions that are made infrequently and under high uncertainty – exactly the kinds of decisions we make when developing strategy. When you bring together people with shared experiences and goals, they end up telling each other stories that are generally positive. For example, research shows that 80 percent of executives believe their product stands out from the competition – but only 8 percent of customers agree.
Opportunities of the strategy
Corporate strategy is essentially about beating the market. The economic profit – the total profit after deduction of the cost of capital – measures the success of this outperformance. A McKinsey study shows that from 2010 to 2014 an average company reported an annual operating profit of $920 million. To achieve this profit, they invested $9,300 million of invested capital, resulting in a return of 9.9 percent. After investors and funders received 8 percent in return for the use of their funds, $180 million in economic profit remained.
Five fields of success
What can you do now to improve the chances that your company will rise to the top? Adding more and more information helps to increase the chances of your company’s success. Even if you know your overall chances, you need to understand which of your characteristics and actions can best help you increase them. We have identified ten performance levers. We have divided these levers into three categories: Equipment, trends and movements. Your endowment is what you start with, and the variables that are most important are your sales (size), your leverage (leverage) and past investments in R&D (innovation). Trends are like winds that push you forward, slap you in the face or affect you from the side. The key variables there are your industry trend and your involvement in growth regions.
But the biggest difference is your activities and measures – what you do with your starting position and how you react to trends. Research has shown that the persistent pursuit of the following five fields leads to success:
Systematic M&A.
Year after year, you need a steady stream of transactions, each of which does not exceed 30 percent of your market capitalization, but over a ten-year period will account for at least 30 percent of your market capitalization. Performing three transactions per year means maintaining a constant pipeline of potential targets, subjecting 20 companies to due diligence and submitting about five bids.
Dynamic reallocation of resources.
The successful companies change their capital expenditures agilely and invest in the promising business areas, while those business areas that are likely to bring less success are allocated less money. Experience shows that at least 50 percent of investment spending is shifted between business units within a decade.
High capital expenditure.
This leverage leads to success when your ratio of capital expenditure to sales is among the top 20 percent in your industry. This typically means spending 1.7 times the industry median.
Productivity program strength. This means improving productivity to a level sufficient to be at least in the top 30 percent of your industry. This includes, for example, consolidated business units and sites, automated processes and much more.
Improvements in differentiation.
For the innovation and price advantages of the business model to increase your chances of success, your gross margin must reach the top 30 percent in your industry. For example, expand your addressable customer base.
What can we do for you?
Strategy development is a journey with many unknowns. Nevertheless, success can be increased with careful and realistic analysis. We are happy to support you with our neutral view and challenge your assumptions.