Did you ever wonder whether it’s more important, in terms of profitability, to be in the right industry or to be good at what you do?
As it turns out, the UCLA business school professor I’m about to introduce you to answered that question over 15 years ago, in research that still holds up today. The answer is:
"Being in the right industry does matter, but being good at what you do matters a lot more, no matter what industry you’re in. This study was one of the first entries in what has since become a large body of academic literature on the resource-based view of strategy."
Now, Warren Buffett might take exception to this, at least if you take him at face value when he says that he’ll take a decent company in a great industry over a great company in a lousy industry any time. And, of course, he penned this memorable indictment of the airline industry in his 1992 shareholders’ letter:
"Similarly, business growth, per se, tells us little about value. It’s true that growth often has a positive impact on value, sometimes one of spectacular proportions. But such an effect is far from certain. For example, investors have regularly poured money into the domestic airline business to finance profitless (or worse) growth. For these investors, it would have been far better if Orville had failed to get off the ground at Kitty Hawk: The more the industry has grown, the worse the disaster for owners."
But back to our professor.
He’s Richard
Rumelt, who holds the Harry and Elsa Kunin Chair in Business and Society at the Anderson School of Management at UCLA. And the occasion for this is his talk with McKinsey.
The question that kicks things off, for this "strategy’s strategist," is what precisely is wrong with the strategic planning process in corporate America today. Surveys show increasing levels of dissatisfaction with the entire exercise.
Rumelt’s response is that what passes for strategic planning is often just three- to five-year resource allocation planning. As an example, he cites a (hypothetical) growing retail chain that needs to plan store locations, construction budgets, permitting processes, hiring needs, etc., some years into the future. But to say that its resulting budgetary resource allocations amount to "strategy" is a misnomer and worse.
Strategy, then, is? "A pathway to substantially higher performance." And, according to Rumelt, there are only two ways to get there. The first is to invent or innovate your way to success. "Unfortunately, you can’t count on that."
The other is to "exploit some change in your environment" (he cites consumer tastes, technology, laws, or competitive behavior) "and ride that change with quickness and skill. This second path is how most successful companies make it."
Great; so how do you identify changes?
As they say in Italy, "stai attento." This most closely translates to "be careful," but I prefer its implied meaning of "pay attention." Now, it’s not your job to be gazing at the horizon, trying to foresee changes? Fine. Then appoint a few people to do it. Some key partners, to be sure, but also consider deputizing senior people in IT, in finance, in marketing, and even in HR to spend part of their time blue-skying trends and potential developments, and reaching out to thought leaders in their areas to see what developments might be in the pipeline that could represent either a threat or an opportunity for your firm.
Rumelt cites the example of 3G wireless networks enabling streaming video over cellphones, but he immediately questions whether that opportunity is being over-hyped. He wonders if a GPS-enabled, location-centric search function combined with voice recognition might not be a superior app.
The point is not that he’s right or the streaming-video crowd is right, but the point is this, about strategic thinking:
"Now, speculative judgments like these are the essence of strategic thinking, and they can be the starting points for taking a position. Can you predict clearly which positions will pay off? Not easily. If we could actually calculate the financial implications of such choices, we wouldn’t have to think strategically; we would just run spreadsheets. Strategic thinking is essentially a substitute for having clear connections between the positions we take and their economic outcomes.
"Strategic thinking helps us take positions in a world that is confusing and uncertain. You can’t get rid of ambiguity and uncertainty—they are the flip side of opportunity. If you want certainty and clarity, wait for others to take a position and see how they do. Then you’ll know what works, but it will be too late to profit from the knowledge."
To go after changes, you have to "take a predatory posture." Rumelt had the chance, in the mid-1990’s, to interview a cross-section of senior executives in the global electronics industry, and he asked what seems a fairly simple question: Who was the leader in their market and how did they get there? And, what is your own firm’s strategy?
He reports that, consistently, executives told him the leader in their industry sector jumped through a window of opportunity that had opened (if not the first to jump through, the most acrobatic, if you will).
But here comes the shocking disconnect: When asked what their firms’ strategies were, not a single one responded that it was looking for the next window of opportunity.
"I heard a lot about doorknob polishing. They were doing 360-degree feedback, forming alliances, outsourcing, cutting costs, and so on. None of them even mentioned taking a good position quickly when the industry changes."
Contrast this with Rumelt’s talk with Steve Jobs a few years later. Rumelt posed the obvious question: Despite Apple’s remarkable come-back after Jobs’ return, the regnant Wintel standard was simply too entrenched for Apple ever to be more than a niche player. So, Steve, what’s the longer-term strategy? Jobs "0didn’t agree or disagree with my assessment of the market. He just smiled and said, “I am going to wait for the next big thing.”"
The next big thing, as it turned out, was iTunes and the iPod. As Rumelt points out, at the time you couldn’t pick up a magazine or a newspaper without reading about Napster. The change, in other words, was hiding in plain sight.
Here comes into play one of Rumelt’s key insights: That innovation usually occurs at the intersection of two otherwise disconnected areas of expertise. As for the iPod, it was the combination of musical industry expertise (without a vested interest in the incumbents), the Web, and Apple’s brilliance at consumer hardware and software. With another company called Sherline Products that Rumelt mentions, which makes small machine tools going for about $3,000 for model makers, it was the founder’s background as both a hobbyist and a professional machinist.
I wish I could lay out more generalizable principles of how to "stai attento" to emerging trends, or how to come up with unorthodox combinations of cross-functional expertise, but strategy doesn’t lend itself to that. Were there a formula, everyone could do it. Clearly, everyone cannot—or does not.
Rumelt is still willing to take a stab at how to do this. Asked "how do we know which changes are important and which resources to combine?," here’s his thoughtful response (emphasis mine):
"That’s a very tough question. It is a key issue—the next frontier. And it is underresearched, underwritten about, and underunderstood. I call it “strategy dynamics.â€
"Most of the strategy concepts in use today are static. They explain the stability and sustainability of competitive advantages. Strategy concepts like core competencies, experience curves, market share, entry barriers, scale, corporate culture, and even the idea of “superior resources†are essentially static, telling us why a particular position is defensible—why it holds the high ground.
"If the terrain never changed, that would be the end of the story. High ground is always high, and low ground is always low. But in business, unlike geology, change happens in years rather than millennia. […]
"Strategy dynamics studies how those changes would shift each dimension of an industry. Would the industry become more concentrated or less? More integrated or less? Would there be more product differentiation or less? More segmentation or less? Given consumer desires and available technologies, how should the industry or business look in, say, ten years? Where are the economic forces trying to take you? Should your strategy ride those forces or fight them?
"There are tools and exercises that help trigger inductive insights about dynamics. One is a list of common biases—the kind of list that helps some people look beyond the standard consensus view of what is happening."
Another useful thought experiment Rumelt discusses is what he calls "value denials." Value denials are simply products or services that are not offered but that readily could be, and for which clients would clearly pay. One example is an airline ticket that guarantees your luggage won’t be lost. Not for sale. But some people would clearly pay for it. A value denial.
In the music industry, a clear value denial (the industry’s own fault, but that’s a tale for another day) was the inability to buy the two or three good tracks on a 15-track CD. iTunes squared that circle.
What services might your clients be looking for that no firm offers, at any price? That are simply not on the market?
And, most importantly, how do you explore what those might be?
The answer is both self-evident and plays precisely to the strengths of top-notch law firms:
"A small group of smart people. What else can I say? Doing this kind of work is hard. A strategic insight is essentially the solution to a puzzle. Puzzles are solved by individuals or very tight-knit teams. For that, you need a small group."
And, by the way, he would flatly prohibit PowerPoint. "People end up with bullet points that contradict one another, and no one notices! It’s simply amazing."
Instead? Opt for three coherent paragraphs, "having to link your thoughts, giving reasons and qualifications."
This writer could not agree more fervently.
But back to law-firm land.
What changes might we see, that an astute firm could capitalize on?
I’m not charging you McKinsey rates to read this, so the following is worth what you’re paying, but here are a few thoughts. What might you make out of:
- The carbon-footprint consciousness, green awareness revolution?
- The mis-pricing (non-pricing?) of CDO’s and other debt instruments in the current sub-prime/hedge fund/private equity backfiring?
- The likelihood (I’m non-partisan, but I think this is the common wisdom) that our next President will not be a Republican?
- The drumbeat of calls for substantial reform of healthcare (even if they are beaten back, as before)?
Those are just ideas, and I haven’t deputized any senior partners or C-level executives to scout the horizon. But be my guest and do so.
Update from a reader (16 August):
Hey, Bruce,
Great points all. Your observations seem to underscore the pivotal challenge posed by the fact that law firm management is just not terribly sophisticated (on the whole). It seems to me that the potential up-sides presented by the nexus of increased global presence, increased firm size (and thus increased profits), the threat of non-US firms getting relative scale and efficiency (technology) advantages through non-lawyer capital, and the slow drip drip increase in acceptance of possible non-lawyer management teams, all point to a true quantum leap in the effectiveness, enjoyment and efficiency in the practice of law. We’ll see if our profession is up to the mental shifts necessary to get us there.
On that score, it’s all in the perceived interests of individual lawyers taken in the aggregate. Once that aggregate opinion realizes that true professional management is a necessity (and, also perhaps, the necessity for non-lawyer capital), the pesky little details of making all these changes actually work through the system will happen almost of their own accord (e.g., the seemingly insurmountable prohibitions against Clementi-type reforms). Mon dieu, if Glass-Steagall (http://en.wikipedia.org/wiki/Glass_Steagal_Act) can go down in flames with not much more than a twitter, we attorneys can get over the porous taboos of lawyers and “the profane” getting together both in terms of management and ownership.
Best regards,
Pete
Update: 23 August 2007. Another reader I hear from regularly writes as follows (with explicit permission to publish her comments here):
Bruce,
Many thanks for your review of UCLA Professor Dick Rumelt’s interview with The McKinsey Quarterly. It’s a great commentary on how most enterprises confuse “strategy” with “next year’s budget.” He offers some empirically derived insights about competitive advantages – how to spot them and how to profit from them.
Another admiring reader also posted a comment expressing appreciation for your commentary on Dr. Rumelt’s work. He mentioned five factors he thinks have potential upsides for law firms. Although he didn’t distinguish between the impacts he predicts on most law firms vs. market-leading firms, I believe that four of those five factors are actually unrelated to (or their impacts are not yet known on) the performances of market-leading firms, to wit:
1. Increased global presence
Instead of placing offices in many countries around the world, top-flight law firm market leaders generally rely on best-friends relationships with other local market-leading firms. These market-leading best friends stick with their own core strengths, their own core locales, and their own core client industries, and they trust their best friends to do the same.
2. Increased firm size (and thus increased profits)
Actually, law firms’ per equity partner profitability is uncorrelated with lawyer headcount. The correlation coefficient between these two metrics among Am Law 200 firms’ performances during FY 2006 is an astonishingly low .04, i.e., only 4% of the variance among law firms’ per equity partner profitability can be explained by the variance in lawyer headcounts.
3. Non-US firms gaining relative scale and efficiency (technology)
I’m unaware of any demonstration that many law firms, on any sides of the Atlantic or the Pacific, have either the technological or the business process analysis rigor to become scalable in ways that distinguish them from their competition, other than in ways that are available to the entire industry. “Technology” is a tide that rather quickly lifts all boats. The few firms that have progressed much beyond off-the-shelf legal technology know who they are, and I don’t want to out them and their competitive advantages here.
4. Advantages through non-lawyer capital
What are these undefined sustainable advantages? A single labor/employment firm in Australia has taken on investors. Let’s wait and see how that plays out before anointing law-firms-gone-public as the next new multidisciplinary threat. I’m a skeptic, betting that investors and lawyers will both soon freak out, since their respective DNAs seem highly incompatible and uncombinable. Opinions of knowledgeable people clearly differ on this subject.
5. Acceptance of possible non-lawyer management teams
One well-designed study has found a significant relationship between the number of C-level positions in a law firm and a firm’s ability to avoid complete failure, although this is a far cry from proving that adding more C-level execs improves a firm’s performance. Nonetheless, I’ll readily stipulate that in 2007 many professional COOs (and other C-level execs) carry weightier portfolios more capably than they did a decade ago. The real question is whether and when a successful firm chairman or a managing partner might leave one firm to lead another firm.
Returning to Dr. Rumelt’s work, my own observations of the law firm industry parallel his corporate findings: Market-leading law firms are sharply distinguished by their abilities to predict quickly and accurately where the next new legal need will appear – at the nexus of business / economic / legal / cultural / political changes. Lawyers (and marketers) in market-leading firms lean their heads out the windows of their rapidly moving practices, scanning the horizon, searching for early warning signals. They then quickly position themselves to benefit immediately from imminent changes.
Not all their predictions come true. But waiting to see in which direction the law firm herd will lumber next is NOT the way to find a competitive advantage. Nor is growing ever larger, locating offices in dozens of countries, serving countless client industries, or creating new practice groups with abandon. More focus, not more bloated diversification, is the path to success for law firms with sufficient self-discipline to recognize and respond to critical emerging legal needs.
Respectfully,
Ann Lee Gibson
*********
Ann Lee Gibson, Ph.D.
Ann Lee Gibson Consulting
1404 Southern Hills
West Plains, MO 65775
office 417-256-3575
agibson@annleegibson.com
www.annleegibson.com
Thanks, Ann. The jury does remain out on many of these topics, which is wh at makes them so fascinating. I remain more sanguine about public ownership, however. Some firms will get it right, I’m confident.
