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Chapter One
WHAT STRATEGY PARADOX?


Most strategies are built on specific beliefs about the future. Unfortunately, the future is deeply unpredictable. Worse, the requirements of breakthrough success demand implementing strategy in ways that make it impossible to adapt should the future not turn out as expected. The result is the Strategy Paradox: strategies with the greatest possibility of success also have the greatest possibility of failure. Resolving this paradox requires a new way of thinking about strategy and uncertainty.


Here is a puzzling fact: the best–performing firms often have more in common with humiliated bankrupts than with companies that have managed merely to survive. In fact, the very traits we have come to identify as determinants of high achievement are also the ingredients of total collapse. And so it turns out that, behaviorally at least, the opposite of success is not failure, but mediocrity.

There is more at stake here than simply observing that accomplishing anything worthwhile requires at least making the attempt, while those who venture nothing can only ever avoid disappointment. Theodore Roosevelt, the twenty–sixth president of the United States, explained this much to us when he argued that the credit belongs to those actually “in the arena,” whose faces are marred by “dust and sweat and blood.”(1) His point was that victory demands valiant action, and that valiant action necessarily brings with it the risk of defeat.

In business, the kinship between these antipodes runs far deeper, to the nature of the actions one must take in order to prevail. Therein lies the strategy paradox: the same behaviors and characteristics that maximize a firm’s probability of notable success also maximize its probability of total failure.


THE SIMILARITY OF OPPOSITES

Many opposites are not nearly as different as they first appear. For example, as Nobel Peace Prize winner Elie Wiesel observed, the opposite of love is not hate, but indifference; for at a minimum, to love or hate someone is to have intense emotions toward them.(2) We see how the similarities between love and hate often outweigh the differences when one is transformed into the other, a phenomenon that literature—from Gilgamesh to Shakespeare to Harlequin Romances—has exploited and explored for millennia.

The psychological proximity of love and hate is part of the hard–wiring of the human psyche. Dan Gilbert explains, in his book Stumbling on Happiness, that the same neurocircuitry and neurochemistry triggered in response to stressful events (“flight or fight”) are also triggered in response to sexual arousal.(3) As a result, when we are stressed in the presence of a person we find sexually attractive, we have a tough time telling what we are responding to: are our passions inflamed (hate) because of a stressor, or are we aroused (love) because of the attractive person?

In the 1994 movie Speed starring Keanu Reeves and Sandra Bullock, Bullock’s character, Annie Porter, appeals to this possible confusion when she notes, upon finding herself in the hero’s arms after several near–death experiences, that “relationships that start under intense circumstances, they never last .”

Call it an “emotional paradox”: two very different dispositions—loving and hating—can have far more in common with each other than a seemingly intermediate state.


The strategy paradox is visible only when we can put under the microscope strategies whose only flaw was that they flopped. Chapter 2 explores two such strategies: Sony’s Betamax VCR and its MiniDisc music player. In both cases, the company never set a foot wrong by the lights of how one is supposed to build a successful strategy: it understood its customers, identified viable market segments, developed cutting–edge products, executed flawlessly, and monitored and responded to its competitors’ countermoves. Yet, in both cases, Sony came up short because the commitments the company had to make in the pursuit of greatness were undermined when the perfectly reasonable assumptions behind those commitments turned out to be wrong. Sony’s failures were not a consequence of bad strategy, but of great strategy coupled with bad luck. Sony did everything necessary to maximize its chances of success, yet those same actions exposed it to the possibility of near–total defeat. In other words, when key uncertainties broke against it, Sony became a victim of the strategy paradox.

The purpose of this book is to describe how the strategy paradox can be resolved. In what follows, a new principle I call Requisite Uncertainty and a new management tool I call Strategic Flexibility provide a way for managers to implement the kinds of strategies that can deliver outstanding results while minimizing exposure to the vagaries of fate.


1.1 HIDDEN IN PLAIN SIGHT

Why is this the first you have heard of the strategy paradox? After all, there is no shortage of well–designed and well–executed studies offering useful insights into the defining characteristics of successful firms. Similarities to failed firms and the importance of luck have not featured prominently.

The reason most business research misses the strategy paradox is that few studies ever examine failure. In some cases, this is because pursuing the secrets of success seems more rewarding than picking through the wreckage of failure. In other cases, it is simply a flawed method: researchers embrace the idea that by studying winners they can discern their defining characteristics, forgetting that the factors differentiating winners from losers can be identified only by analyzing both. Finally, there is the reality that failures are often harder to document because failed companies are typically no longer available for study.

In light of these difficulties, researchers often compromise, comparing companies that have been very successful over ten or fifteen years (focal companies) with companies that have been less successful over that same time period (comparison companies). Some studies look for firms that have done very poorly over that time, and others look for comparison companies that have actually done pretty well—just not nearly as well as their focal companies. Either way, however, comparison companies have at least survived for the period in question, and over a ten–year period, mere survival is actually a pretty high bar.(4)

What this means is that most studies of the determinants of success have based their conclusions upon comparisons of the exceptional with the mediocre. Studies that systematically seek out successful companies will necessarily find those that in the past made the right commitments. And because the comparison companies are always firms that have performed less well, but not failed completely, they will tend to be firms that have avoided high–risk, high–return strategies. A review of more than thirty empirical studies, published in academic journals over the past twenty years, exploring the relationship between strategy and performance found none that had accounted for this bias.(5)

By examining primarily those companies that have guessed right and comparing them with those that have avoided guessing, what has been largely missed is the critical importance of managing uncertainty. The gallant charge and the cowardly retreat are not the only alternatives to catastrophic defeat. There is a way to boldly go, yet mitigate risk without compromising performance. Describing that solution is the promise of this book.

Accepting the strategy paradox forces us to accept mediocrity, giving up a chance at greatness as the price of our continued corporate existence. Resolving it will free us from a debilitating trade–off between risk and return and allow us to strive to be first without giving up the hope that we will last.


1.2 MUST COMMIT

The cause of the strategy paradox is as obvious as it is overlooked. A successful strategy allows an organization to create and capture value. To create value, a firm must connect with customers. For a firm to capture value, its strategy must be resistant to imitation by competitors. Satisfying customers in ways competitors cannot copy requires significant commitment to a particular strategy, that is, strategic commitments, to unique assets or
to particular capabilities.

Commitments are a powerful determinant of success because they make a strategy difficult to imitate. To reduce strategic risk, many firms invest only in what has been shown to work. Since these latecomers wait while some firms—the lucky ones—make what happen to be the right commitments, lucky firms enjoy a period of relatively little competition: it takes time to replicate capabilities so painstakingly created. For example, new products snapped together from off–the–shelf components are usually easily imitated by competitors, while those based on proprietary technologies developed over years are far likelier to be the foundation of a durable franchise. The downside of commitment is that if you make what happen to be the wrong commitments, it can take a long time to undo them and make new ones.

The strategy paradox, then, arises from the collision of commitment and uncertainty. The most successful strategies are those based on commitments made today that are best aligned with tomorrow’s circumstances. But no one knows what those circumstances will be, because the future is unpredictable. Should one have guessed wrong and committed to the wrong capabilities, it will be impossible to adapt—after all, a commitment that can be changed was not much of a commitment. As a result, success is very often a result of having made what turned out to be the right commitments (good luck), while failed strategies, which can be similar in many ways to successful ones, are based on what turned out to be the wrong commitments (bad luck). In other words, the strategy paradox is a consequence of the need to commit to a strategy despite the deep uncertainty surrounding which strategy to commit to. Call this strategic uncertainty.

New research detailed in Chapter 3 suggests that often the main factor separating success and failure is indeed luck. Firms that avoid strategic risk survive but do not prosper. Firms that accept strategic risk reap either great reward or utter ruin. For now, these seem to be the only alternatives to failure, and firms are forced to choose. There is no intrinsic merit in opting for greater returns over survival or vice versa; the problem is that firms must choose.

The Sony examples, referred to earlier, are not unique. The strategy paradox is more than a theoretical possibility or a curiosity; it is a general condition. As recounted in Chapter 3, an analysis of the competitive strategies of several thousand operating companies reveals that organizations pursuing the most commitment–intensive strategies generate the highest returns, but they also suffer the highest mortality rates. Seen in this light, Sony’s failures were not a consequence of avoidable mistakes but the result of making commitments—the defining element of successful strategy—despite inescapable uncertainty. And when those uncertainties were resolved to Sony’s detriment, it paid the price.

The strategy paradox rests on two premises: commitments cannot be adapted should predictions prove incorrect; and predictions are never reliably or verifiably correct. Are these premises true?


1.3 CAN’T ADAPT

For all we might think we know about how to make organizations agile, flexible, and adaptive, the data suggest strongly that, if anything, competitive advantage is eroding faster than ever. This acceleration is interpreted by some to mean that there is a greater need than ever for adaptable enterprises. Such an observation is entirely correct. Unfortunately, the acuteness of the need does not mean that it can be satisfied.

Most organizations exhibit some degree of adaptability. However, as explained in Chapter 4, adaptability is far less useful than we might like. Specifically, adaptability is viable only when the pace of organizational change matches the pace of environmental change. When the environment changes either faster or slower than the organization, adaptability is no longer sufficient. The bad news is that every organization will at some point face one or both of two types of mismatch between the two rates of change, and each can prove devastating.

Fast change leaves an organization’s capabilities optimized for an environment that suddenly no longer exists. For example, when the price of oil rose 400 percent in a matter of weeks in the early 1970s, North American automakers found that the mainstay of their product lines—full–sized cars—were singularly inappropriate to the new competitive conditions. Unfortunately, it took those same automakers years to design, manufacture, and market more fuel–efficient models, and they lost valuable market share to better–positioned competitors. (Ironically, the tide turned in their favor in the mid-1990s when cheap gas made SUVs all the rage; their good fortune began to evaporate once again in the face of high-priced petrol in the mid-2000s.)

Slow change prompts an organization to adapt to incremental changes in the environment around it, and because of these incremental adaptations, the company often fails to see the need for a more fundamental transformation. The auto sector’s response to the current oil crisis may be subject to this slow change pathology. As oil prices have crept up, automakers have responded by extending the life of the internal combustion engine by dramatically increasing fuel economy and creating hybrid electric engines, among other technological advances. But the day may well come when, due either to the need to limit carbon emissions for environmental reasons or the inability of the general economy to absorb still further increases in oil prices, the internal combustion engine must be abandoned. Should that day arrive, companies that have been exploiting their adaptive capacity could well be overtaken by firms that are already aggressively pursuing alternative technologies intended to replace, rather than merely extend, a centuryold technology.

Compounding the difficulties of responding to fast and slow change is the fact that most competitive environments are characterized by multiple rates of change, creating the impossible organizational task of changing at different rates at the same time.

As a result, adaptability cannot expect to resolve or even mitigate the strategy paradox.