Two uncomfortable strategic truths face the vast majority of executives and companies – and probably you, too. First, you don’t have a powerful strategy. And second, you aren’t doing much about it.
Though both statements may sound extreme, they are the clear implication of new McKinsey research on how companies create value and allocate resources.
The widespread absence of a powerful strategy is clear from our recent study of 3 000 of the world’s largest companies, which finds that just 20% in that group create 90% of its total economic profit.
The rest of the companies, more than 2 400, simply do not have a strategy that effectively outperforms the market.
A second new McKinsey study delves into the question of what executives are doing about their strategic shortfall, and concludes that most are not doing enough.
While they should increase investment in the parts of their business with the best shot at creating value and cut investment in business lines that are tapped out, they don’t.
Instead they divvy up their corporate resources in the same way year after year, giving businesses, whether great or weak, the same slice of corporate resources they had the year before.
Of 1 500 multi-business companies examined each year over the course of two decades, only a minority actively shifted a substantial share of their resources to their most high potential growth businesses.
Even between 2007 and 2010, when tough external conditions should have forced hard internal choices, leaders remained stuck in their tracks. A great opportunity for change was wasted.
Inertia is expensive. The corporate minority that actively reallocate their resources do much better financially than those that don’t.
These ‘dynamic reallocators’ produced a median total return to their shareholders of 10% per year between 1990 and 2010. That is far ahead of the 6% return earned by the companies which rarely reallocate – the ‘dormant reallocators.’
And while resource dynamism made a big difference, the bar we set for it was not extraordinarily high: Companies moving just 41% of their capital base between businesses or to new business areas over a 15 year period made the cut.
Warren Buffett once said: “I was wired from birth to allocate capital.” Lucky for him! What should the vast majority of executives who aren’t genetically endowed like Buffett do to boost their odds of identifying good strategic bets, and then putting their money where their strategy is?
1. Retool your strategy development process
Good analysis in the hands of smart managers does not automatically yield great strategy. The process of developing that strategy is critical.
Nearly eight in ten executives surveyed by McKinsey describe the strategic planning processes at their companies as more geared to confirming existing hypotheses than testing new ones.
There are techniques to fix that problem.
Among them: Foster debate, create ‘challenger roles’ to institutionalise give and take, cut through the politics, and seek external perspective, even if it’s as simple as using outside analysts’ market predictions or making customer visits.
Create a corporate-resource map that is granular enough to show specifically where resources are currently deployed. This data will enrich discussion and help make the case for reallocation even to powerful division leaders who don’t benefit from it themselves.
2. Test your new strategy
Strategy is not a procedural exercise, but a way of thinking. To stimulate strategic thinking, answer this question honestly: When you look objectively at your assets, capability and market position is there any reason to believe you can create disproportionate value?
One way to look at competitive advantage is to define it as an imperfection in the market, something which stops competitive forces from sucking away profit. Such advantages are scarce and often fleeting.
- Does your strategy tap a true source of advantage?
- Put you ahead of trends?
- Does it rest on unique and proprietary insights?
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How confident are you that you can ‘beat the market’?
3. Execute decisively
Speed may be scary but one thing leaders need not worry about is reallocating too much. McKinsey research finds no evidence that the rewards of greater reallocation taper off.
Managers appear to be most at risk of doing too little, not too much. How much reallocation is needed varies, of course.
Some successful re-allocators enter and exit businesses entirely. But many more make less dramatic changes, shifting resources, year after year, to build up the best part of their business, and simultaneously pruning their less successful lines.
Whatever the degree of change required at your company, make it. Companies run by decisive CEOs rack up more economic profit – what’s left of operating profit after the cost of capital is subtracted – than competitors do.
Returns to shareholders of reallocating firms are strong. It’s not just business, it’s personal: The CEOs willing to make the tough tradeoffs also have longer tenures in their jobs than those who are slow to shift assets.
A better company, richer shareholders, and more job security are the rewards for being bold enough to build a powerful strategy and translate it into a real reallocation of resources.
Retool. Test. Execute
These are the priorities for leaders concerned that their strategy is undifferentiated or isn’t backed and implemented with sufficient resources.
While change is never comfortable, our research suggests the bigger risk for many companies is not facing up to their strategy problem – or doing nothing about it.
This article was a collaboration by Michael Birshan, Martin Hirt and Kurt Strovink.