Good Strategy, Bad Strategy – Lessons

Strategy has always been a less-explored topic for me, and I’m glad I recently stumbled upon the book Good Strategy, Bad Strategy by Richard P. Rumelt. It’s arguably one of the most practical and useful books in the field of strategy, and an easier read compared to many other books on the subject. I’ve decided to share a distilled version of my notes on the book here on my blog, in hopes that it might be useful to others as well.

The book has three parts. Part 1 defines strategy and what good and bad strategies look like. Most importantly, it introduces the three main parts of a good strategy: a diagnosis, a guiding policy, and a set of coherent actions. Part 2 is the largest part and focuses on all the ways you can create and employ strategies that harness various sources of power. Lastly, Part 3 teaches the fundamental skills you need to think clearly about strategy and form sound judgments. Below you can find my notes on the book.

Part 1: Good and Bad Strategy

1. Leaders must say no to a wide variety of actions and interests, to create a focused strategy. It’s at least as much about what you don’t do as it is about what you do.
2. Companies often don’t act by design, rather sticking with best practices.
3. Always consider the competition when thinking about the strategy of a company
4. Hallmarks of bad strategy:
   1. Fluff: inflated and complicated words and buzzwords -> True expertise results in the opposite of fluff, i.e. makes things understandable rather than complicated
   2. Failure to face and define the challenge
   3. Mistaking goals/desires for strategy
   4. Bad strategic objectives, i.e. ones that are impracticable or fail to address critical issues
5. Instead of “Vision -> Mission Statement/Core Values -> Goals -> Strategies”, find the fundamental obstacles. A strategy is essentially a response to a challenge/obstacle.
6. Pure force or motivation doesn’t work. You need competent strategic leadership and insights to succeed.
7. It’s generally to keep a close look on what’s changing in your industry to get an edge over the competition.
8. Goals are overall values and desires, while objectives are specific operational targets. The leader builds and constantly adjusts the bridge between goals and objectives.
9. Instead of a long to-do list, focus on the very few most important objectives.
10. Bad strategy isn’t miscalculation. It’s the active avoidance of the hard work of creating a good strategy. Three common forms:
    1. Avoiding making difficult decisions: focus means letting go of some goals. Change will hurt some people and it’s inevitable.
    2. One-size-fits all, template-style strategies, e.g. mission/vision statements
    3. New Thought: the fallacy that thinking about success leads to success
11. Consensus is often impossible or just bad. The prospect of choice makes people present their sharpest arguments to win, paving the way for good decision making.
12. Andy Grove’s pivotal question: “If we hired a new CEO, what would he do?”
13. Good strategy has 3 parts:
    1. A diagnosis: defines the nature of the challenge. It’s a simpler model of the complex reality of the situation.
    2. A guiding policy: the overall approach to cope with or overcome the obstacles. Doesn’t define specific actions. Acts like guardrails on a highway.
    3. A set of coherent actions to carry out the guiding policy. These actions are performed in coordination with one another.
14. A guiding policy creates advantage by:
    1. Anticipating actions and reactions, e.g. those of competitors
    2. Reducing the complexity and ambiguity of the situation
    3. Exploiting the leverage of concentrating effort on a pivotal aspect of the situation
    4. Creating actions that are coherent and synergistic
15. You can’t find the “correct” diagnosis or policy—they are simply judgments and decisions. Still, they focus action and resource allocation.
16. About coherent action:
    1. The necessity to act is the greatest tool for sharpening strategic ideas.
    2. Design is the engineering of fit among parts, specifying how actions and resources will be combined.
    3. A proximate objective is a powerful way to coordinate actions. Putting a man on the moon was a proximate objective.
    4. Strategy is visible as coordinated action imposed on a system. Thus, it is an exercise in centralized power. It works because decentralized decision making doesn’t always work in the benefit of the whole. Still, coordination is costly, as it interrupts and de-specializes people. Consequently, you should only seek coordinated policies when the gains are very large.
    5. Good strategy + Good organization = Specialize on the right activities + Impose the essential amount of coordination

Part 2: Sources of Power

1. Good strategy harnesses power and applies it where it will have the greatest effect. Here’s some of the sources of power:
   1. Leverage: focusing effort on the most pivotal/critical aspect in a situation. Identifying it takes insight and anticipation (insight into predictable behaviors of others). Works because resources and attention are limited. Plus, with certain activities there is a “threshold effect”, where any effort below a certain threshold has little to no payoff, necessitating focus.
   2. Proximate Objectives: the leader’s responsibility is to hand the organization a problem it can actually solve, by first reducing the ambiguity and complexity and creating a simpler problem. The more dynamic/uncertain a situation, the more proximate the objective should be. The important thing is to take an increasingly strong position and create options, as chess players do for the major part of a chess game, rather than directly try to mate their opponent.
   3. Chain-link Systems:
      1. happens when the performance of a system is limited by its weakest subunit. In this case, the chain is not made stronger by strengthening the other links, or it may actually become weaker by reducing the profit of the whole.
      2. Identifying and eliminating limiting factors is an especially valuable skill. When stuck, you must—at least temporarily—tip the balance toward centralized direction, decision making, and coordination, and be willing to accept responsibility for short-term losses before reaching the desired final state.
      3. These systems can cause excellence, as well as being stuck. A good leader strives to create constellations of activity that are chain-linked. It adds extra effectiveness and makes the business more immune to imitation by the competition. In other words, it creates sustained strategic advantage.
   4. Using Design:
      1. Strategy is not simply a choice or a decision. Often, it’s a novel response designed as an answer to a challenge. Thus, a master strategist is a designer rather than a decision maker.
      2. Design problems involve mutual adjustments of many factors to find the best configuration. There are sharp costs to getting them wrong, and great gains in getting them right.
      3. You must know enough about all the subsystems, and hold it all in your head to imagine/design a configuration that can be effective
      4. The greater the challenge, the greater the need for a good, coherent, integrated, design-type strategy. Higher integration also means narrower focus, less flexibility, and more fragility. It’s also harder to create.
      5. A strategic resource is a kind of property that’s fairly long lasting that has been built, designed, or discovered by a company and that competitors can’t duplicate without suffering a net economic loss. In the long run, they may become an impediment to innovation, so well-led companies must from time to time cast aside old resources. Plus, the bloat and laxity of incumbents is what opens the door to upstart companies with a tightly coordinated competitive strategy. You should learn design-type strategy from those upstarts, rather than the mature company’s posturing.
   5. Focus:
      1. Definition: attacking a segment of the market with a business system supplying more value to that segment than the other players can
      2. You must always do your own analysis of a company, if you are serious about strategy work. A good place to start is usually to examine the competitive environment. Another helpful trick is to look at the policies of the company that differ from the norm, and figure out the common target of these policies.
      3. The trick to answering general, formless questions is to replace general nouns with specific examples. For example, “What’s the gain in this policy for small companies?” becomes “What’s the gain in this policy for Camber’s Cans?”
      4. Many companies, especially large complex ones, don’t really have strategies to be identified. That lack of focus is why they don’t achieve a breakthrough in any area.
   6. Growth:
      1. Growth itself doesn’t create value. Healthy growth is not engineered. It’s the result of growing demand for special capabilities or of expanded capabilities, superior products and skills, successful innovation, efficiency, cleverness, and creativity. It shows up as a gain in market share and a superior rate of profit.
      2. Buying a company only makes sense if you can buy it for less than it’s worth, or if you are specially positioned to add more value to the target than anyone else. People often advise you to buy companies because they will earn big fees.
   7. Advantage:
      1. It’s rooted in differences/asymmetries. The leader’s job is to identify which asymmetries are critical, i.e. can be turned into important advantages.
      2. No one has an advantage at everything, but rather in certain kinds of rivalry under particular conditions. Press where you have advantage and sidestep situations in which you don’t.
      3. Competitive advantage means you can produce at a lower cost than can competitors, or/and you deliver more perceived value.
      4. Sustainable competitive advantage is one that can’t easily be duplicated by competitors. You need isolating mechanisms to protect them, such as patents, reputation, network effects, and tacit knowledge and skill gained through experience.
      5. A system/product that’s available for purchase by all doesn’t give you an advantage, by definition.
      6. Wealth increases when competitive advantage, or the demand for its underlying resources increases.
      7. The 4 ways to increase value:
         1. Deepening advantages: increase value to buyers, reduce costs, or both. Improvement in systems/processes and products is not a natural process and can’t be done using pressure or incentives alone. Reexamine each aspect of product and process and don’t assume everyone knows what they are doing. Plus, develop deep knowledge of and empathy for your customers to make the best products.
         2. Broadening the extent of advantage: bringing an advantage to new fields and new competitions. Requires looking at the special skills and resources underlying a competitive advantage. Be warned that thinking your competence lies in generalities such as “management” or “transportation” can make you diversify into products and processes you know nothing about. Finally, you should know a brand’s value comes from guaranteeing certain characteristics of the product.
         3. Creating higher demand: an advantage becomes more valuable when the number of buyers, or the quantity demanded by each buyer increases.
         4. Strengthening isolating mechanisms: e.g. stronger patents. A useful method is to create a moving target for imitators by constantly improving, or simply altering, your products and methods. You also become much harder to imitate when your advantage is based on proprietary knowledge (i.e. gained from customers or generated based on internal processes), rather than readily available scientific knowledge.
   8. Using Dynamics:
      1. One way to attain high ground is by creating it through innovation. Another is to exploit a wave of change. These waves are out of the control of any one organization, and erase old advantages and enable new ones. You need to understand the likely evolution of the landscape and channel resources and innovation toward positions that will become high ground. It’s the leader’s job to provide that insight and inventiveness.
      2. The main challenge is not forecasting, but understanding the past and present. The notion that the world is changing so fast these days that it’s become unpredictable is false. Historical perspective helps fight that misjudgment.
      3. Find the patterns in what could be clues to a coming substantial wave of change. See beyond the immediate changes and consequences, and think about the second-order changes that have been set into motion, e.g. innovations and domination in computing used to rely on hardware and assembling hordes of engineers, but shifted to small teams of great skill, and to software.
      4. To make good judgments about how a wave of change might play out, you must acquire enough expertise to question the experts.
      5. It is in moments of industry change that skills at strategy are most valuable.
      6. Understanding economy-wide or industry-wide change is very hard, and your strategy merely has to be more right than those of your rivals.
      7. Guideposts to find your way through the fog:
         1. Escalating fixed costs, especially in product development, lead to consolidation, as only the bigger players can cover these costs.
         2. Major changes in government policy, especially deregulation, can cause a wave of change. In the case of deregulation, formerly regulated companies suffer from inertia and are slow to adapt.
         3. Predictable biases in forecasting: People rarely predict that a business or economic trend will peak and then decline (e.g. especially visible in durable goods). In addition, battle of the titans in times of change is only sometimes true, and middle-sized and smaller firms can often compete and win. Finally, adopting the strategies of the current largest players, the most profitable ones, or ones with the largest rates of stock price appreciation, is often a mistake.
         4. Incumbent response: we should expects incumbents to resist a transition that threatens to undermine the complex skills and valuable positions they have accumulated over time.
         5. Attractor state: it’s based on changes that affect efficiency in meeting buyer demand, e.g. IP was more efficient, and won.
   9. Inertia and Entropy:
      1. Inertia in business is an organization’s unwillingness or inability to adapt to changing circumstances. Even with change programs in full effect, it may take years.
      2. Entropy: weakly managed organizations tend to become less organized and focused over time. There is a need for constant work to maintain purpose, form, and methods even if there are no changes in strategy or competition.
      3. Knowing about the inertia of rivals is as important as knowing your own strengths.
      4. When dealing with entropy and inertia, organizational renewal becomes a priority. It’s an intense strategic challenge to diagnose the causes and effects, create a guiding policy, and design a set of coherent actions to change routines, culture, and the structure of power and influence.
      5. Types of inertia:
         1. Routine: “the way things are done” both limits action to the familiar, and filters and shapes managers’ perceptions of issues. It necessitates replacing people deeply invested in the old methods, as well as to reorganize business units around new patterns of information flow. Hiring consultants, hiring managers from other firms with better methods, acquiring companies that use better methods, and redesigning the routines are other standard tools to fix it. The main barrier is often the perceptions of top management; once convinced, change can be quick.
         2. Culture:
            1. Culture is the elements of social behavior and meaning that are stable and strongly resist change. They can’t be changed quickly or easily.
            2. Steps to fix:
               1. Simplify. Remove excess layers of administration and halt nonessential operations to illuminate inefficiencies and obsolete units.
               2. Separate the units that don’t need to work in close coordination and break up (fragment) some
               3. Triage. Units will either close down, be repaired, or form the nuclei of a new structure.
            3. Good performance shouldn’t save a unit with bad culture.
            4. To change a group’s norms and values, its alpha member must be replaced by someone who expresses different norms and values. They must also set a new, challenging goal, which in turn changes the work habits and routines within the unit.
            5. After most units are working well, install new coordinating mechanisms and reverse some of the fragmentation you originally employed to break inertia.
         3. By proxy:
            1. Definition: when existing profit sources are threatened by change = The inertia of customers
            2. It goes away when the organization decides that adapting to the new circumstances is more important than holding on to old profit streams. It poses great danger to small attackers who took advantage of the inertia.
      6. Unmanaged human structures tend to become less ordered and less focused over time. That’s why the daily work of managers matters.
      7. When a company is fully decentralized, especially when the brands are defined around price ranges, the blurring of boundaries and internal competition are bound to happen. It may hurt the company as a whole.
   10. Putting It Together:
       1. Nvidia succeeded in an environment of intense competition mainly because of good strategy. Some of their most notable policies and actions include:
          1. Heavy investment in simulation and emulation technologies, to reduce the time it took to design new chips
          2. Creating a 6-month release cycle, as opposed to the industry-standard 18-month cycle
          3. Going for a Unified Driver Architecture
       2. Often, when a powerful company starts pursuing many goals in different directions and fails, it was enticed by the threat of a rival.

Part 3: Thinking Like a Strategist

1. The Science of Strategy:
   1. Good strategy is built on functional knowledge about what works, what doesn’t, and why.
   2. Your organization builds knowledge by actively exploring its arena in a process called scientific empiricism, where each new strategy is a hypothesis to be put to the test and learned from. Because you are trying to push boundaries, there’s bound to be lots of ambiguity.
   3. Pure deduction can only be used when there are no new opportunities or risks, which is rarely the case. It assumes that everything worth knowing is already known, and thus kills innovation and change in companies and societies. We need other tools such as induction, analogy, judgment, and insight.
   4. You need intense attention to data and to what works.
   5. An anomaly is a fact that doesn’t fit existing wisdom. It’s valuable and can be used to push the boundaries.
2. Using Your Head:
   1. Being strategic generally means being less myopic than others, and than your undeliberative self.
   2. Our instincts and first judgments are often wrong; you should learn to recognize which situations require deeper reflection. Strategy work is by definition about hard and complex problems, and they deserve more than a quick closure.
   3. The most important strategy tool is the ability to think about our own thinking, and to make judgments about our own judgments.
   4. Strategy work requires lots of knowledge about the specifics, plus on-the-ground experience, but that’s not enough. 3 essential skills are needed:
      1. Have a variety of tools for fighting your own myopia and for guiding your attention.
      2. Develop the ability to question your own judgment. If it can’t withstand an attack, it’s not good enough.
      3. Get into the habit of making and recording judgments so you can improve.
   5. 4 techniques:
      1. The kernel: make a list of the diagnosis, the guiding policies that it leads to, and the coherent actions that result from them.
      2. Problem-solution: gain a change in perspective by shifting your attention from “what” should be done to “why” it should be done—to the actual problems the choices try to address.
      3. Create-destroy: don’t just create shallow alternative judgments that reinforce your first one. Alternative judgments should flow from a reconsideration of facts and address real issues of any already developed judgments.
      4. Practicing judgment: commit your judgments to paper and take positions whenever you can, to learn and improve. In any situation, choose an interpretation of which issues are critical and which are not, and choose an action.
3. Keeping Your Head:
   1. You need independent and careful assessment of the situation. Bad strategy follows the crowd, using popular slogans rather than insights.
   2. Trusting the stock market’s judgments is dangerous yet widely practiced. Some people even substitute stock performance for analysis, which is terrible.
   3. Social herding: when everyone looks to the other people in the group to make decisions, assuming at least some of them know things we don’t. Can lead the members of the group to make uninformed decisions.
   4. Inside view: the tendency to believe that “this case is different”, despite related pertinent evidence.
   5. An important quality of a good leader is putting the situation in perspective and having cool-minded judgment. That helps mitigate social herding and inside view biases.
   6. The inside view presses us to ignore the lessons of other times and other places, believing that our company, or nation, or era is different. You need to learn the lessons taught by history and by other people in other places.

Afterword

That’s it—thanks for reading! If you liked this post, you may also want to check out my last post on my top 10 books of the past decade. See you soon!