Posted: March 7th, 2019

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SPOTLIGHT ON STRATEGY FOR TURBULENT TIMES

Spotlight ARTWORK Tara DonovanUntitled, 2008, polyester film

HBR.ORG

What Is the Theory

f ̂ Fiof y

Firm? Focus less on competitive advantage and more on growth that creates value, by Todd Zenger

f asked to define strategy, most execu- tives would probably come up with something like this: Strategy involves discovering and targeting attractive markets and then crafting positions that deliver sustained competitive advan- tage in them. Companies achieve these positions by configuring and arranging resources and activities to provide either unique value to customers or common

value at a uniquely low cost. This view of strategy as position remains central in business school curricula around the globe: Valuable positions, protected from imitation and appropriation, provide sustained profit streams.

Unfortunately, investors don’t reward senior managers for simply occupying and defending po- sitions. Equity markets are full of companies with powerful positions and sluggish stock prices. The retail giant Walmart is a case in point. Few people would dispute that it remains a remarkable firm. Its early focus on building a regionally dense network of stores in small towns delivered a strong positional advantage. Complementary choices regarding ad- vertising, pricing, and information technology all

continue to support its low-cost and flexibly mer- chandised stores.

Despite this strong position and a successful stra- tegic rollout, Walmart’s equity price has seen little growth for most of the past 12 or 13 years. That’s be- cause the ongoing rollout was anticipated long ago, and investors seek evidence of newly discovered value—value of compounding magnitude. Merely sustaining prior financial returns, even if they are outstanding, does not significantly increase share price; tomorrow’s positive surprises must be worth more than yesterday’s.

Not surprisingly, I consistently advise MBA stu- dents that if they’re confronted with a choice be- tween leading a poorly run company and leading a well-run one, they should choose the former. Imag- ine assuming the reins of GE from Jack Welch in Sep- tember 2001 with shareholders’ having enjoyed a 40- fold increase in value over the prior two decades. The expectations baked into the share price of a company like that are daunting, to say the least.

To make matters worse, attempts to grow often undermine a company’s current market position. As Michael Porter, the leading proponent of strat- egy as positioning, has argued, “Efforts to grow blur

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SPOTLIGHT ON STRATEGY FOR TURBULENT TIMES

uniqueness, create compromises, reduce fit, and ultimately undermine competitive advantage. In fact, the growth imperative is hazardous to strategy.” Quite simply, the logic of this perspective not only provides little guidance about how to sustain value creation but also discourages growth that might in einy way move a compeiny away from its current stra- tegic position. Though it recognizes the dilemma, it offers no real advice beyond “Dig in.”

Essentially, a leader’s most vexing strategic chal- lenge is not how to obtain or sustain competitive advantage—which has been the field of strategy’s primary focus—but, rather, how to keep finding new, unexpected ways to create value. In the following pages I offer what I call the corporate theory, which reveals how a given company can continue to create value. It is more than a strategy, more than a map to a position—it is a guide to the selection of strategies. The better its theory, the more successful an organi- zation wül be at recognizing and composing stiategic choices that fuel sustained growth in value.

The Greatest Theory Ever Told Value creation in all realms, from product devel- opment to strategy, involves recombining a large number of existing elements. But picking the right combinations out of a vast array is like being a blind explorer on a rugged mountain range. The strategist CEinnot see the topography of the surrounding land- scape—the true value of various combinations. All he or she can do is try to imagine what it is like.

In other words, leaders must draw from available knowledge and prior experience to develop a cogni- tive, theoretical model of the landscape and then make an educated guess about where to find valu- able configurations of capabilities, activities, and re- sources. Actually composing the configurations will put the theory to the test. If it’s good, the leader will gain a refmed vision of some portion of the adjacent topography—perhaps revealing other valuable con- figurations and extensions.

Companies that enjoy sustained success are typi- cally founded on a coherent theory of value creation. All too often such companies get into trouble when the founders’ successors lose sight ofthat theory— whereas turnarounds, when they occur, often in- volve a return to it. The history of the Walt Disney Company provides a case in point. Its founder had a very clear theory about how his company created value, which was captured in an image held in the company’s archives and reproduced here (see the

exhibit “Walt Disney’s Theory of Value Creation in Entertainment”).

The image depicts a range of entertainment- related assets—books and comic books, music, TV, a magazine, a theme park, merchandise licensing— surrounding a core of theatrical films. It illustrates a dense web of synergistic connections, primarily between the core and other assets. Thus, as precisely labeled, comic strips promote films; films “feed ma- terial to” comic strips. The theme park, Disneyland, plugs movies, and movies plug the park. TV publi- cizes products of the music division, and the film di- vision feeds “tunes and talent” to the music division. Walt’s theory in words might read: “Disney sustains value-creating growth by developing an unrivaled ca- pability in family-friendly animated (and live-action)

Walt Disney’s Theory of Value Creation in Entertainment This 1957 map of Walt Disney’s vision defined his company’s key

assets, including a valuable and unique core, and identified patterns

of complementarity among them. It implicitly revealed the industry’s

future evolution and provided guidance concerning adjacent competitive

terrain that Disney might explore. The asset and capability combinations

that emerged from the theory have evolved with time, but the theory

itself has not fundamentally changed.

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COMIC STRIPS

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WHAT IS THE THEORY OF YOUR FIRM? HBR.ORG

Traditionally, practitioners see strategy as the process of discovering and targeting attractive markets and then crafting positions that will deliver sustained advantage in them.

Unfortunately, investors don’t

reward senior managers for

simply occupying and defend-

ing market positions. They look

for evidence that the company

can continually find new

competitive advantages.

To do that, managers

need a corporate theory that

explains how they can create

value by combining the

company’s unique resources

and capabilities with other

assets.

A good theory incorporates

foresight about an industry’s

future, insight into which inter-

nal capabilities can optimize

that future, and cross-sight

into which assets can be

configured to create value.

The successes of the Walt

Disney Company and Mittal

Steel were driven by good

corporate theories. In contrast,

AT&T’s strategic actions after

the spin-off of the Baby Bells

provide a cautionary tale about

what can happen when

a large company lacks a

coherent theory.

films and then assembling other entertainment as- sets that both support and draw value from the char- acters and images in those films.”

The power of this theory was perhaps most viv- idly revealed following Walt’s death. Within 15 years leadership at Disney seemed to lose sight of his vi- sion. As the company’s films markedly shifted away from the core capability of animation, the engine of value creation ground to a halt. Film revenues de- clined. Gate receipts at Disneyland flattened. Charac- ter licensing slipped. The Wonderful World of Disney, the TV show that American families had gathered to watch every Sunday evening, in a nationwide em- brace, was dropped from network broadcast. By the time I entered college, in the late 1970s, the Disney franchise many of us had grown to love as children had all but disappeared.

Attesting to the depths of Disney’s disarray, cor- porate raiders in 1984 attempted the unthinkable: a hostile acquisition of the company with a view to selling off key assets, including the film library and prime real estate surrounding the theme parks. The capital markets embraced this idea, leaving the board with a critical choice: sell Disney to the raiders, who would pay a significant price premium but dis- mantle the company, or find new management. The board chose the latter and hired Michael Eisner.

Eisner rediscovered Walt’s original theory and used it to guide a heavy investment in animated pro- ductions, generating a string of hits that included The Little Mermaid, Beauty and the Beast, and The Lion King. Over the next 10 years Disney’s box office share jumped from 4% to 19%. Character licensing grew by a factor of eight. Attendance and margins at the theme parks rose dramatically. Disney’s share of income from video rental and sales soared from 5.5% to 21%. Eisner opened new theme parks, made fur- ther investments in live-action films, and expanded into adjacent businesses consistent with the theory.

including retail stores, cruise ships, Saturday morn- ing cartoons, and Broadway shows. By essentially dusting off Walt’s theory and aggressively pursu- ing strategic actions consistent with it, Disney won growth in its market capitalization from $1.9 billion in 1984 to $28 billion in 1994.

That cycle has repeated itself in the years since: Although the move into Broadway shows was com- plementary to animated films, character licensing, and theme parks, other strategic moves, such as the 1988 acquisition of a Los Angeles TV station, the 1995 purchase of Cap Cities/ABC, and the 1996 purchase of the Anaheim Angels, failed to reflect the theory’s logic. Meanwhile, Eisner allowed the core animation asset to atrophy again as the company failed to keep up with technology trends and the best-in-the-world animators migrated from Disney to Pixar. Disney gained access to their skills through a contract, but the relationship between Disney and Pixar grew con- tentious and was finally severed just before Eisner stepped down, in October 2005.

His successor, Robert Iger, quickly moved not merely to repair the Pixar relationship but to acquire the company, for more than $7 billion. Disney’s re- cent acquisitions of Marvel and Lucasfilm fuel this central asset, although they carry the company into somewhat unfamiliar terrain: The Marvel and Star Wars casts are quite different from Disney’s tradition- ally princess-heavy character set. Whether this stra- tegic experiment proves to be value-creaüng remains to be seen. But Walt Disney’s road map for growth has clearly endured long past his death, providing a remarkable illustration of posthumous leadership.

The Three “Sights” of Strategy The Disney strategy has all the hallmarks of a power- ful corporate theory. It has consistently given senior managers enhanced vision—a tool they repeatedly used to select, acquire, and organize complementary

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SPOTLfGHT ON STRATEGY FOR TURBULENT TIMES

Steve Jobs’s Corporate Theory of Value Creation On August l o , 2on, Apple surpassed ExxonMobil to become the world’s most valuable corporation—a remarkable feat for a company left for dead in 1997. Although credit for Apple’s success correctly goes to Steve Jobs, the real substance of his genius has often been misunderstood. Like Walt Disney’s, his greatest contribution was not a product, a plan, or a managerial attribute; it was a corporate theory of value creation- one that nearly every purported industry or strategy expert consistently encouraged him and his successors at Apple to abandon. Jobs’s theory was apparent in the

famous Apple II computer, launched in

1977. Although its inner workings were

the brainchild of Apple’s cofounder, Steve

Wozniak, Jobs was responsible for the

friendly packaging, the sleek casing, and

the marketing-focused company that

brought the product to consumers with

tremendous fanfare. A wave of entries into

the personal computing space followed,

each introducing a unique software and

hardware platform.

But in 1981 the industry was trans-

formed when IBM introduced the IBM

PC. It was an instant success, widely

applauded for its open architecture. The

industry rapidly moved toward generating

IBM-compatible software and hardware.

Cheaper, faster, and greater storage

capacity quickly came to define competi-

tive success. Competing platforms rapidly

disappeared and is years of intense

competition ensued, until Dell eventually

discovered a powerful position.

Jobs, however, continued managing to

a very different set of performance criteria,

reflecting his theory of value creation.

That theory not only guided Apple’s strat-

egy in computing but defined a succession

of future moves and choices. It took on

greater clarity with time, but essentially it

held that consumers would pay a premium

for ease of use, reliability, and elegance in

computing and other digital devices, and

that the best means for delivering these

was relatively closed systems, significant

vertical integration, and tight control over

design.

Like Disney’s, Jobs’s theory incorporated

all three strategic “sights.” It was inspired

by foresight about the evolution of cus-

tomer tastes. Jobs recognized that com-

puters would become a consumer good,

akin to the Sony Walkman. He believed

that consumers would appreciate aesthet-

ics and aspired to create a device with the

elegance of a Porsche or a well-designed

kitchen appliance.

His insight was that the internal capabil-

ity most critical to value creation in this

bundles of assets, activities, and resources. How can you tell if your own corporate theory is as good? The answer depends on the extent to which it provides what I call the strategic “sights”: foresight, insight, and cross-sight. Let’s look at these a bit more closely.

Foresight. An effective corporate theory ar- ticulates beliefs and expectations regarding an in- dustry’s evolution, predicts future customer tastes or consumer demand, foresees the development of relevant technologies, and perhaps even forecasts the competitive actions of rivals. Foresight suggests which asset acquisitions, investments, or strategic actions will prove valuable in predicted future states of the world. It should be both relatively specific and somewhat different from received wisdom. If it is too generic, it won’t identify which assets are valu- able. If it is too widely shared, the desired assets and capabilities will be expensive to acquire (because competed for) or else not unique (and therefore un- likely to create sustained value). Walt Disney’s fore- sight was that family-friendly visual fantasy worlds had vast appeal.

Insight. If competing companies own assets identical to yours, they can replicate your strategic actions with equal or perhaps even refined capac-

ity, thus undermining any superior foresight in your theory. An effective corporate theory is therefore company-specific, reflecting a deep understanding of the organization’s existing assets and activities. It identifies those that are rare, distinctive, and valu- able. Disney’s key insight was recognizing the value of the company’s early lead and substantial invest- ment in animation and its capacity to create timeless, unique characters that, unhke real actors, required no agents.

Cross-sight. A well-crafted corporate theory identifies complementarity that the company is sin- gularly able to assemble or pursue by acquiring as- sets that can be combined with existing ones to cre- ate value. Disney’s theory suggested a broad array of entertainment assets that could draw value from a core of animation.

Together these three sights enable leaders to compose a succession of value-creating actions. Foresight regarding future demand, technology, and consumer tastes highlights domains in which to search for cross-sight. Insight regarding unique as- sets focuses the search for foresight and cross-sight. Cross-sight reveals valuable complementarities, highlighting the domain of foresight.

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WHAT IS THE THEORY OF YOUR FIRM? HBR.ORG

competitive terrain was design. Of course,

that was in part a reflection of his person-

ality: Jobs was a self-proclaimed artist,

obsessed with color, finish, and shape; but

he transferred this obsession to the tech-

nology as well. Walter Isaacson, Jobs’s

biographer, wrote, “He got hives, or worse,

when contemplating great Apple software

running on another company’s crappy

hardware, and he likewise was allergic to

the thought of unapproved apps or con-

tent polluting the perfection of an Apple

device.” In pursuing Jobs’s focus on design,

Apple made heavy R&D investments, much

larger in percentage terms than those of

any of its competitors.

His theory also provided cross-sight, in

that it helped Jobs identify external assets

through which value could be created,

including the graphical user interface (GUI)

technology that Apple obtained from Xerox.

During his famous visit to Xerox, Jobs

repeatedly expressed incredulity that the

company was not aggressively commer-

cializing the technology. He saw that GUI

perfectly fit his theory, because it made

a computer easy to use and attractive

to engage with. Some regard what next

transpired as one of the greatest technol-

ogy transfers in history.

The Macintosh was the first fully formed

embodiment of Jobs’s theory, and it gar-

nered wide acclaim and remarkably high

margins (as Jobs had predicted). But the

IBM standard was already well established,

and the opposing network economics were

overwhelming. Although the Mac survived

as a very profitable niche product. Bill

Gates and others exerted enormous pres-

sure to port the look and feel of the Macin-

tosh operating system to the IBM platform.

Jobs, however, refused to countenance any

such experiment.

For years academics and journalists

derided this strategic refusal. Jobs was

banished from Apple for more than a

decade, in part for his dogged insistence

on sticking to his theory. His subsequent

vindication has become the stuff of legend.

He returned to Apple in 1996, shortly

after the struggling enterprise had been

shopped unsuccessfully to HP, Sun, and

even IBM. Most people anticipated that he

would simply dress the company up for

sale. Instead he reimposed his theory with

a vengeance, trimming the product range

and introducing a new line of Macintosh

products, not available for license. More

important, he used it to explore adjacent

terrain, producing a remarkably success-

ful series of strategic moves across a wide

range of product categories.

Apple was not the first to design a digital

music library, manufacture an MP3 player,

or market a smartphone. But it was the

first to craft and configure those devices

and their user environment with elegant,

easy-to-use designs and with tight control

of complementary products, infrastructure,

and market image. Apple has shown that

Jobs’s theory has broad application beyond

computing, with industries and product

categories ranging from TV, video systems,

home entertainment, portable readers,

information delivery, and even automotive

systems as possible targets. In contrast,

the well-positioned Dell has struggled to

find a way out of a declining PC industry.

When Strategy Lacks a Theory Not all corporate theories are created equal, however, and some companies never discover valuable ones. The story of AT&T is a case in point.

In 1984 the seven regional Bell Operating Compa- nies were spun off from AT&T, eliminating Ma Bell from local telephone service and slashing assets from $150 billion to $34 billion. AT&T was left with its long-distance business, its manufacturing arm (Western Electric), and its R&D organization. Bell Labs. With no clear path for growth, the company needed a new theory of value creation.

Its first strategic actions after the breakup sug- gest that its leaders had composed a theory whereby they would leverage what they perceived as broad managerial competence to invest large cash ñows from long-distance service in diverse acquisitions and new businesses. Over the next several years the company got into data networking, financial ser- vices, computing, and an internet portal. The mar- ket was distinctly unimpressed, and in 1995 AT&T abandoned its diversification theory, announcing that it would divest two key assets, NCR and Lucent Technologies—essentially carving itself into three distinct companies.

Get research paper samples and course-specific study resources under   homework for you course hero writing service – Manage ment quickly composed a new theory that reflected its belief in the value of acquiring the

“last mile” connection to local customers and provid- ing a bundled package of telephone, broadband in- ternet, and cable services. This theory drove a series of costly cable-industry acquisitions in 1998-1999, totaling more than $80 billion. Unfortunately, the theory was rather widely shared by other companies and investors, and purchase prices reflected this (the cost per subscriber exceeded $4,000). Nevertheless, the market initially applauded these moves, driving AT&T’s share price to an all-time high of $60. But by May 2000 the stock had dropped back close to $40 a share. In response, AT&T again began questioning its theory—or at least its ability to sell that theory to Wall Street. In October 2000 the company an- nounced that it would spin ofFthe wireless and cable units, and five years later it put itself up for sale.

The moral of the AT&T story is clear: It pays to invest a lot of time and energy in crafting a robust theory that, like Disney’s, is quite specific as to how combinations of assets create value. AT&T’s first theory following the breakup never made clear how the company’s supposed managerial competence could be uniquely applied to new types of assets; it

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SPOTLIGHT ON STRATEGY FOR TURBULENT TiMES HBR.ORG

lacked insight and cross-sight and certainly any vi- sion of the future. The company’s second theory was equally fiawed: It contained foresight, but in a form that was already widely shared and thus could not generate unique cross-sights.

Bargain Hunting with a Corporate Theory The real power of a well-crafted corporate theory becomes particularly evident when companies go shopping. Value creation in markets always comes down to prices paid, and a good corporate theory en- ables the acquirer to spot bargains that are uniquely available to it.

Mittal Steel is a good example. From its origin, in 1976, until 1989, it was a very small player in an

such assets—especially ones with integrated technol- ogy and large iron ore deposits—was unthinkable, so the field was wide open for Mittal.

Mittal’s insight was its understanding of the value of DRI and its own ability to lead turnarounds in formerly state-owned enterprises. Its foresight was an early recognition of the value of iron ore as- sets—given the strong growth in demand for steel in emerging economies—and the virtues of industry consolidation. Its cross-sight was to recognize the types of assets that could benefit from the compa- ny’s distinct capabilities.

By 2004 Mittal had emerged as the world’s largest and lowest-cost steel producer. Lakshmi Niwas Mit- tal, the company’s owner, is now one of the world’s wealthiest people. This success came from having a

An effective corporate theory is company- specific; it identifies those assets and activities that are rare, distinctive, and valuable.

industry consistently ranked at the bottom in fi- nancial performance. Mittal began as a small mill in Indonesia, where it developed a capability in a new iron ore input technology called direct reduced iron (DRI), which provided mini-mills with a high-quality alternative to scrap metal.

Mittal simply grew with Indonesia’s emergence as a tiger economy. But in 1989 it made its first major ex- pansion move by acquiring a troubled steel operation owned by the government of Trinidad and Tobago— a mill that was operating at 25% capacity and losing $1 million a week. Mittal quickly proceeded to turn this business around as it transferred knowledge, de- ployed DRI, and increased sales. A succession of sig- nificant acquisitions followed over the next 15 years, primarily of assets in the former Soviet bloc; each proved to be a gold mine.

A clear and simple corporate theory guided this acquisition program: Mittal knew how to create value from poorly understood and poorly managed state- owned steel operations in developing economies where demand for the product was growing fast. To other steel companies, many of which were focused on improving their internal operations, acquiring

corporate theory that functioned as a rather remark- able treasure map, one that continues to reveal as- sets uniquely valuable to Mittal.

THE PSYCHOLOGIST Kurt Lewin famously commented, “There is nothing so practical as a good theory.” The- ories define expectations about causal relationships. They enable counterfactual reasoning: If my theory accurately describes my world, then when I choose this, the foUowing will occur. They aie dynamic and can be updated on the basis of contrary evidence or feedback. Just as academic theories enable scien- tists to generate breakthrough knowledge, corporate theories are the genesis of value-creating strategic actions. They provide the vision necessary to step into uncharted terrain, guiding the selection of what are necessarily uncertain strategic experiments. A better theory yields better choices. Only when your company is armed with a well-crafted corporate theory will its search for value be more than a ran- dom walk. 0 HBR Reprint R1306D

B a Todd Zenger is the Robert and Barbara Frici< Profes- n n sor of Business Strategy at Washington University in St. Louis’s Olin Business School.

78 Harvard Business Review June 2013

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