11.

THE TRAP OF BACKWARD-LOOKING STRATEGY

The future cannot be logically deduced from its past.

—JOHN DEWEY¹

Strategy has been a major activity in business for decades. Why then didn’t strategy reveal the disaster that was unfolding from maximizing shareholder value, or from the resort to the “corporate cocaine” of share buybacks, or from mass offshoring? Was it because strategy couldn’t help? Or is the practice of business strategy inherently flawed? To help answer these questions, let’s look at the sad story of the Monitor Group.

The Monitor Group was a strategy consulting firm cofounded in 1983 by the legendary business thinker Michael Porter. In November 2012, Monitor was unable to pay its bills and filed for bankruptcy protection. Why didn’t the highly paid Monitor consultants use their own strategy analysis to save themselves?

After all, Monitor’s demise hadn’t happened like a bolt from the blue. The death spiral had been going on for some time. In 2008, Monitor’s consulting work slowed dramatically during the financial crisis. In 2009, the firm’s partners had to advance $4.5 million to the company and defer $20 million in bonuses. Then Monitor borrowed a further $51 million from the private equity firm Caltius Capital Management. Beginning in September 2012, the company was unable to pay the monthly rent on its Cambridge, Massachusetts, headquarters. In November 2012, Monitor missed an interest payment to Caltius, putting the notes in default and driving the firm into bankruptcy.²

Was it negligence, like the cobbler who forgot to repair his own children’s shoes? Had Monitor tried to implement its own strategy framework and executed it poorly? Or had Monitor implemented the strategy well but the strategy didn’t work?³

The story of Monitor is a strange tale. It began in 1969, when Michael Porter graduated from Harvard Business School and crossed the Charles River to get a doctorate at Harvard’s Department of Economics. There he learned that excess profits were real and persistent in some companies and industries because of structural barriers to competition. To the public-minded economists in the Department of Economics, the excess profits of these low-competition situations were an important problem to be solved.

Porter saw that what was a problem for the economists was, from a business perspective, a solution to be pursued. It was even a silver bullet. An El Dorado of unending above-average profits? Protected by permanent structural barriers? Exactly what business executives were looking for—a shortcut to fat city!

Why go through the risk and hassle of creating bold new products and services when the firm could simply position its business so that structural barriers ensured endless above-average profits?

Why not call this trick “the discipline of strategy”? Why not announce that a company occupying a position within a sector that is well protected by structural barriers would have a “sustainable competitive advantage”?

Why not proclaim that finding these El Dorados of unending profits would follow, as day follows night, by having highly paid strategy-analysts doing massive amounts of rigorous data collection and analysis? Which CEO would not want to know how to reliably generate perpetual profits? And why not set up a consulting firm that could satisfy that want?

And so it was that in March 1979, Michael Porter published his findings in Harvard Business Review in an article entitled “How Competitive Forces Shape Strategy.” He followed it up the next year with his book Competitive Strategy.⁴ These writings started a revolution in business strategy. Michael Porter became to the new discipline of business strategy “what Aristotle was to metaphysics.”⁵

Better yet, the newborn profession of business strategy presented itself as a master discipline—the discipline that synthesizes all of the other functional subdisciplines of management into a meaningful whole. It was even presented as defining “the purpose of management and of management education.”⁶

In 1983, Porter cofounded his consulting company, the Monitor Group, which over the succeeding decades generated hundreds of millions of dollars in fees from clients and provided rich livelihoods for other consulting firms, like McKinsey, Bain, and BCG.

Porter became “a giant in the field of competition and strategy,” writes Joan Magretta in her 2012 book, Understanding Michael Porter: “Among academics, he is the most cited scholar in economics and business,” she writes. “At the same time, his ideas are the most widely used in practice by business and government leaders around the world. His frameworks have become the foundation of the strategy field.”⁷

There was just one hitch. What was the intellectual basis of this now vast enterprise of locating a firm’s “sustainable competitive advantage”? Porter might have offered ways to create exciting new lines of business that would be difficult to compete against. Or he might have proposed management actions that could enhance profits from existing businesses. But unending above-average profits that could be deduced from the existing structure of the industry? Here we are in the realm of unicorns and phlogiston. Ironically, like the search for the Holy Grail, it was the very fact that the goal was mysteriously elusive that drove executives onward to continue the quest.

These strategic planning efforts entailed massive data gathering and analyses, as every conceivable facet of the competitive landscape was explored. But because there was no data on the future, the data gathering was inevitably about the past, from which extrapolations of the future were made. The data was also biased in another way, because there was no data on the unknown, only the known. This meant that possibilities beyond what was currently known about the industry didn’t show up in the analyses.

The comfort that was gained from detailed analysis was thus inherently backward-looking. The possibility that the future might be very different from the past was masked by the seeming solidity and comprehensiveness of the data and the analyses that had been assembled. Thus, fast-growing and small competitors often didn’t look like significant risks even when they began to make inroads. Unexpected moves by competitors were often absent from the analyses. Shifts in technology and customer attitudes and lifestyles were missed. The life expectancy of current businesses tended to be overestimated. Overall, the assurance that the future was secure—based largely on the thoroughness of the analyses of data from the past—was illusory.

Yet massive backward-looking strategy exercises continued. Talk of “rigorous analysis,” “tough-minded decisions,” and “hard choices” combined to hide the fact that there was no evidence that sustainable competitive advantage could be created in advance by studying the past structure of an industry. It didn’t hurt the business of strategy consulting that the approach to strategy was—and still is—taught as a compulsory subject in business schools, leading to generations of executives who have been indoctrinated in this thinking.

Although the conceptual framework could sometimes shed light on excess profits in retrospect, it was generally unhelpful in predicting them in prospect. Backward-looking strategies are of course 100 percent accurate in hindsight, but in foresight, they miss the unexpected and the unforeseen. “The point is not that the strategists lack clairvoyance; it’s that their theories aren’t really theories—they are ‘just-so’ stories whose only real contribution is to make sense of the past, not to predict the future.”⁸

Why had strategy gone astray? How had business managed to turn strategy into something that was no help in dealing with the future? Had Porter misconceived the very idea of strategy? Does Agile management have any need for strategy? To answer these questions, we need to look at the broader history of strategy.

Strategy is in fact a very old idea. It got an early start in the sixth century BC, with the appearance of the Chinese military treatise The Art of War, attributed to Sun Tzu, a high-ranking military general and strategist of the time. It consists of insights and maxims that still guide military leaders today:

“War is a necessary evil that must be avoided whenever possible.”

“War should be fought swiftly to avoid economic losses.”

“Avoid massacres and atrocities because this can provoke resistance.”

Nevertheless, a systematic consideration of military strategy only began in the late-eighteenth century as part of the Enlightenment belief in applying reason to all aspects of human activity. Strategy came to be seen as developing the perfect comprehensive plan on a map for aligning and deploying the armed forces. The actual execution of military operations was a matter of tactics for lower-level folk, who would, in theory at least, implement the plan as articulated at the top.

In practice, however, the gap between strategy and implementation created risks of miscommunication, and of a lack of commitment to implement the plan as conceived. Moreover, high-level strategy was likely to be devised without the vital insights of those with more specific and up-to-date knowledge of what was happening on the ground.

Over time, frustration with strategy so conceived led to the emergence in the nineteenth century of the German theorist Carl von Clausewitz, who argued in his famous (but unfinished) book, On War, that strategy is shaped by “a remarkable trinity—composed of primordial violence, hatred, and enmity.”⁹ Human action took place amid “the fog of war” and was affected by the “friction” from the unexpected interaction of different factors, in which rational planning could only play a limited role.

The implications of “the fog of war” and the “friction” that arose between conception and implementation were further developed by Helmuth von Moltke, who was appointed Chief of the Prussian (later German) General Staff in 1857. The dictum that made him famous was: “No plan of operations extends with any degree of certainty beyond the first encounter with the main enemy force.”¹⁰

In some ways, von Moltke can be seen as the godfather of Agile management. To cope with uncertainty, von Moltke developed and applied the concept of Auftragstaktik (literally, “mission tactics”), a strategic approach stressing decentralized initiative within an overall strategic design. Von Moltke had no time for perfect comprehensive plans. He believed that, beyond calculating the initial mobilization and concentration of forces, leaders at all levels of the force needed to make decisions based on an assessment of a fluid, constantly evolving situation within an overall strategic design.

In the twentieth century, von Moltke’s thinking grew steadily more influential in the military and in due course became the formal doctrine of the U.S. Army—at least on the battlefield. The Army in its formal theory of warfare thus contrasts information-based “detailed command” with action-oriented “mission command.”¹¹

Detailed command assumes that the world is deterministic, predictable, orderly, and certain, while mission command accepts that the world is probabilistic, unpredictable, disorderly, and uncertain.

Detailed command leads to centralization, coercion, formality, tight rein, imposed discipline, obedience, compliance, optimal decisions that take place later, and a focus on harnessing ability at the top—in a word, bureaucracy. By contrast, mission command is characterized by decentralization, spontaneity, informality, loose rein, self-discipline, initiative, cooperation, acceptable decisions that are made faster, and a focus on harnessing ability at all levels—in essence, Agile management.

The mission-command approach to strategy leads to a more flexible approach to operations, with a greater understanding throughout the organization and, overall, a more agile and effective organization.¹² In the twentieth century, the military steadily shifted from information-based strategy to mission-command strategy, particularly as warfare became more asymmetric.

Yet at the very moment that the military was abandoning top-down, information-based strategy for the conduct of its operations, strategists in business were embracing it. Strategy in business in the 1980s thus emerged within the conceptual framework of top-down, information-based strategy, with elaborate exercises to be primarily conducted at the top of the organization with unidirectional communications.

This approach might have been appropriate in a marketplace that was oligopolistic, stable, and predictable. But in business, precisely the opposite was taking place. Globalization, deregulation, and new technology were blowing away most of the barriers that had created the “enduring excess profits” that had so worried Harvard’s Economics Department, and so thrilled the young Michael Porter, back in the 1970s.

Within the broader historical evolution of strategy, the approach was an aberration. The widespread adoption of information-based strategy in business, built on data from the past, helps explain the frequent outcome of strategic planning exercises to do “more of the same” (see Box 11-1). It also helps explain why firms consistently missed disruptive innovation.¹³ It could hardly be otherwise when firms pursued information-based strategy built on data from the past.

But an information-based approach to strategy was not the only problem embedded in the approach to business strategy. Another was the very conception of strategy.

Porter began his publishing career with his 1979 article for Harvard Business Review, “How Competitive Forces Shape Strategy.” The article was republished by HBR in 2008 with the proud and accurate boast that the article “has shaped a generation of academic research and business practice.”¹⁴

The 1979 article starts with a very strange sentence: “The essence of strategy is coping with competition.”¹⁵ In effect, at the heart of Porter’s concept of strategy is the idea that strategy is about protecting businesses from business rivals. The goal of strategy, business, and business education is to find a safe haven for businesses from the destructive forces of competition.

To accomplish this, Porter argued, a strategist must consider five forces: (1) the bargaining power of suppliers, (2) the bargaining power of customers, (3) the competitive rivalry among existing firms, (4) the threat of new entrants, and (5) the threat of substitute products (see Figure 11-1). The stronger any or all of these forces are, the more competitive the industry will be, and thus the lower the prospects for excess profits. The goal of strategy is to position the firm in a location where those forces are least operative. Therein lies the key to “sustainable competitive advantage.”

Figure 11-1. Porter’s five forces.

Porter’s article thus ignored Peter Drucker’s foundational insight of 1954 that the only valid definition of business purpose is to create a customer. In Porter’s competition-based model, customers are only relevant to strategy if they have bargaining power. The thinking underlying the five-forces notion of business strategy illustrates the pre-Copernican theory of management discussed in Chapter 3, in which the firm is the center of the commercial universe and the customer is a relatively unimportant thing on the periphery, if visible at all (see Figure 3-2).

Defining the essence of strategy as coping with competition also led to the misconception of business as a zero-sum game. As Porter wrote in his 1979 HBR article, “The state of competition in an industry depends on five basic forces. . . . The collective strength of these forces determines the ultimate profit potential of an industry.”¹⁶ On this basis, the ultimate profit potential of an industry is a finite fixed amount: The only question is which firm is going to get which share of it.

Sound business is, however, “unlike warfare or sports in that one company’s success does not require its rivals to fail. Unlike competition in sports, every company can choose to invent its own game,” says Joan Magretta. “A better analogy than war or sports is the performing arts. There can be many good singers or actors—each outstanding and successful in a distinctive way. Each finds and creates an audience. The more good performers there are, the more audiences grow and the arts flourish.”¹⁷

What’s wrong here is the concept of “the essence of strategy.” The essence of strategy is not coping with competition—a contest in which a winner is selected from among rivals. The essence of business strategy is to add value for customers. Porter’s five-forces model of strategy misses the basic point that ultimately customers are the determinant of business success.

The error in thinking that the purpose of strategy is to defeat business rivals rather than add value to customers has of course been aggravated by the epic shift in the power of the marketplace from the seller to the buyer, now that customers have options and reliable information about those options and an ability to communicate with other customers.

In the studies of the oligopolistic firms of the 1950s on which Porter founded his theory, it appeared that structural barriers to competition were widespread, impermeable, and essentially permanent. Over the following half century, the winds of globalization and the Internet blew away most of these barriers, leaving the customers in charge of the marketplace. Except for a few areas, like health and defense, where government regulation offers some protection, there are no longer any safe havens for business. National barriers collapsed. Knowledge became a commodity. New technology fueled spectacular innovation and rapid change. Entry into existing markets was startlingly easy. New products and new entrants abruptly redefined whole industries, killing old ones and creating new ones.

The “profit potential of an industry” turned out to be not a fixed quantity, with the only question being who would get which share, but rather a highly elastic concept, expanding dramatically at one moment or collapsing suddenly at another, with both competitors and innovations seemingly coming out of nowhere. Disruptive innovations destroyed company after company that believed in its own “sustainable competitive advantage.” Just look at the diminished fortunes of once-flourishing category leaders such as Nokia, Kodak, Sony, Research in Motion, Motorola, HP, Borders, Circuit City, Sears, and JCPenney.

Or look at the massive businesses generated by Amazon, Apple, Facebook, Google, or Netflix when they provided new value to customers. These firms have not merely been extracting a larger share of “the profit potential of their industries” or “taking advantage of structural barriers in their industry.” They have been creating vast new markets.

There is thus a straight line from the conceptual error at the outset of Porter’s writing to the debacle of Monitor’s bankruptcy. Monitor wasn’t killed by any of the five forces of competitive rivalry. Ultimately, what killed Monitor was the fact that its customers were no longer willing to buy what Monitor was offering. Monitor failed to add value to customers. Eventually customers realized this and stopped paying Monitor for its services. Ergo, Monitor went bankrupt. Monitor was crushed by the single most dominant force in today’s marketplace—the very force that is missing from the five forces: the customer.

It is therefore not really a surprise that Monitor went bankrupt. The more interesting question is: How was Monitor able to make so much money from such an illusory product for so long? Part of the answer is that Porter’s claim of locating a firm’s sustainable competitive advantage had massive political, social, and financial attraction for top management.

Embedded in Porter’s approach to strategic planning are certain assumptions. First, strategy is about the selection of markets and products. Second, these decisions are responsible for the value that the firm creates. And third, the master decider is the CEO. “Strategy, says Porter, speaking for all the strategists, is thus ‘the ultimate act of choice.’ The chief strategist of an organization has to be the leader—the CEO.”¹⁸

Strategy so conceived leads to “the division of the world of management into two classes: ‘top management’ and ‘the rest.’” Strategy thus “defines the function of top management and distinguishes it from that of its social inferiors.”¹⁹ That which is done at the top of an organizational structure is strategic management. Everything else is the menial task of operational management.

Strategy consultants “insist on this distinction between strategic management and lower-order operational management. Strategic (i.e. top) management is a complex, reflective, and cerebral activity that involves interpreting multidimensional matrices. Operational management, by contrast, requires merely the mechanical replication of market practices in order to match market returns. It is a form of action, suitable for capable but perhaps less intelligent types.”²⁰

The practice of consultant-driven strategy thus fueled the mythology of the CEO as a “super-decider” and lent credence to the C-suite’s soaring compensation. The attraction of this kind of strategic planning was precisely that it advanced the political, social, and financial pretensions of the C-suite.

The consultants in these strategy engagements were not usually people with deep experience or understanding of what customers might need or what. They were not generally experts in building cars or making mobile phones or building great software. They were often part-time academics or numbers-people offering financial solutions to problems that required real-world answers. That didn’t matter, because their most important role was that of courtiers performing the ceremonial function of paying homage to the warrior gods in the C-suite.

Through the insistence that the C-suite alone could select the appropriate strategic plan for the future, strategic planning served the function of imposing the direction set by the top on the organization below. The fact that the plans conceived in isolation might not fit the actual marketplace, even at conception, was less important than who was deciding. Nor did it matter that in an increasingly VUCA world, even good plans selected by the top quickly got out of sync with changing conditions. The C-suite would be the ones anointed to fix such issues, with, of course, fresh consultant help.

The top-down approach to strategy was thus a corporate ritual. It was “to CEOs what ancient religions were to tribal chieftains,” writes the former strategy consultant Matthew Stewart in The Management Myth. “The ceremonies are ultimately about the divine right of the rulers to rule—a kind of covert form of political theory.” It is “like a ritual rain dance. It has no effect on the weather that follows, but those who engage in it think that it does.”²¹

Eventually, ceremonial rain dances come to be recognized for what they are. The search for “sustainable competitive advantage” through studying the existing structure of the industry became increasingly implausible. Toward the end, even Monitor itself had abandoned trying to sell Porter’s five-forces framework, though it continues to be taught in top business schools.²²

By contrast, in Agile management, the idea that competitive advantage can be located has given way to the realization that competitive advantage has to be continuously created. Strategy is not a place—it’s an activity. In Agile management, strategy recognizes that the future cannot be discovered solely by studying mountains of data based on the past or by probing what competitors might be doing. In fact, there is a recognition that in a world of rapid technological change, the future structure of the industry will almost certainly be different from the current one.

Thus, the failure of information-based strategy doesn’t mean that Agile organizations don’t need to pay attention to strategy. Agile management does need to be thinking proactively about longer-term opportunities and threats. As discussed in Chapter 6, the central task of strategy in Agile management is to answer the following questions: How will customers meet their needs in the future? What are the larger needs that actual or potential customers have, only part of which are addressed by current products and services? What approach can our organization take to help meet those needs in a profitable fashion? What benefits will flow from this as compared to costs? Can we do this better than any competitor? How can risk be managed?

A proper approach to strategy in Agile management means emancipating strategy from the sole province of top management and implementing a truly inclusive process in accordance with the Law of the Network. Ideas can come from anywhere, and the insights of the entire organization—and beyond—are mobilized in an effort to imagine and influence the future.

In Agile management, the myth that the top management has a lock on wisdom about the future is set aside, with the realization that strategy is innovation and innovation is everyone’s business.²³ It is recognized that an organization operates as a network with a hierarchy of competence, rather than a hierarchy of authority. Multidisciplinary thinking is needed to translate potential changes into relevant opportunities for delivering fresh customer value and then implement the resulting initiatives.

Inclusion of the whole organization in strategy formulation effectively eliminates the handover hurdle between formulation and execution—a major reason for strategy failure. Devices such as hackathons and boot camps can also help by underlining the importance that the firm attaches to innovation and draw on new ideas from wherever they are.

The inspiration for these shifts is not new. It stems from Helmuth von Moltke in the nineteenth century and the military’s mission command in the twentieth. Business managers need to unlearn the information-based exercises that passed for strategy in the late-twentieth-century business world.

Strategy involves leaders at all levels making decisions based on an assessment of a fluid, constantly evolving situation within an overall strategic design. It accepts that the world is probabilistic, unpredictable, disorderly, and uncertain, and that requires decentralization, spontaneity, informality, loose rein, self-discipline, initiative, and cooperation. Acceptable decisions that are made faster focus on harnessing ability at all levels.

Implementing strategy in an organizationally inclusive fashion will be impossible to accomplish in a top-down bureaucracy, with all its rigidities, layers, and unidirectional communications. Thus, rethinking business strategy for the twenty-first century means remaking the notion of management itself.