The brilliance of a strategy may lie in overcoming powerful secondary effects.

Tuesday, November 4, 2003

Joseph A. Avila, Nathaniel J. Mass, and Mark P. Turchan, The McKinsey Quarterly, 1995 Number 2, http://www.mckinseyquarterly.com/article_page.asp?ar=92&L2=21&L3=34&srid=69

Achieving sustainable growth is a perennial concern for senior managers. Yet the strategies they pursue often capture few or none of the intended benefits. Their efforts are rewarded with outright failure or with short-lived wins followed by rapid deterioration. Consider these cases of thwarted initiatives:

Growing too fast. History is littered with companies that experience "boom and bust": rapid growth followed by steep decline, often into oblivion. In the UK life insurance industry, London Life pursued an aggressive salesforce growth strategy that put it out of business by 1987. Its hiring practices had set off a vicious spiral of falling skill levels, flagging motivation, and sinking performance.
Too much too soon. A polymer company spotted an attractive, fast-growing market and invested heavily in new plant and equipment to meet demand. Four rival suppliers responded by dropping their prices. Though the company succeeded in achieving a large share, eroding margins made the market unprofitable.
From glitter to glut. A leading high-tech company saw first-month orders for its latest product exceed capacity by 30 percent, and got its suppliers to increase their raw component stocks. Two months later, as stockpiles built up, orders collapsed, precipitating a huge "sludge" inventory. The product ended up being branded a dud. It transpired that much of the original demand consisted of "phantom orders" placed by distributors concerned about short supplies. Tight initial capacity had actually boosted early demand.
A fix that failed. Many companies pursue growth by attempting to improve customer satisfaction, often through staff training and skill building. One automotive OEM required its dealers to increase technician training, but saw little improvement in either service performance or customer satisfaction. It had not foreseen that technicians would react to their extra training by spending less time in fault diagnosis, or that dealers funding the training would cut back on their investment in tools and equipment.
Unintended consequences. These frustrating patterns occur in national economies too. In the United States, the 1990 luxury tax was intended to generate an extra $76 million in annual revenues, but it actually yielded only $13 million. The reason: the luxury market for planes, boats, and automobiles dried up overnight after the tax was introduced.

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Why do plans that look good on paper go bad when they are executed?
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Why do plans that look good on paper go bad when they are executed? The problem often lies in what might be called secondary effects—unforeseen by-products of strategy that confound its original intentions. The growth strategy of the polymer company, for instance, took no account of how competitors might react. The company won the volume it sought, but its profits were diminished because of actions by rivals threatened by its new capacity.

We believe that companies wishing to implement a successful and sustainable growth strategy need a better approach—one that takes account of the impact of these secondary effects and helps managers make more informed choices about how to accomplish their objectives.

Achieving sustainable growth

To understand these secondary effects, it is necessary to take a dynamic view of the marketplace—one that anticipates competitive reactions and explicitly incorporates them into strategy. An analytical technique called Business Dynamics has proven especially valuable in this context. Derived from system dynamics, it applies ideas about engineering control feedback to business and economic systems. It is based on six fundamental guiding principles (see the boxed insert).

In the cases below, a Business Dynamics perspective helps to explain how sustainable growth was achieved in two very different businesses.

Service satisfaction in the auto industry

For automotive OEMs, repurchase loyalty—what happens when existing customers return to their current auto maker to purchase their next vehicle —is worth many millions of dollars. As the quality and functionality of most vehicles approach parity, sales and service are growing in importance.

Several auto makers have decided that improving customer satisfaction with service at dealerships would raise repurchase loyalty. They have lavished vast sums and considerable management attention on training and technical support programs—but detected no noticeable impact. What has been going wrong?

The OEMs’ efforts have certainly not been misdirected. Analysis of customer survey data reveals that satisfaction with service accounts for one-third of total customer satisfaction, and is predominantly driven by the ability to repair a vehicle correctly, on time, and at the first attempt. Average dealer performance against this target is 65 percent—meaning that one in three customers would need to go back for further repairs. "Best in class" performance, however, approaches 90 percent, so there is ample room for improvement.

A fix that failed

The traditional solution to this performance shortfall was to establish a policy of mandatory training to make technicians more effective. But extra training meant they spent less time at work. Exacerbated by flat-rate compensation that favored throughput rather than quality of service, pressure mounted at dealerships. The diagnostic stage of the repair process was often rushed, leading to failure to detect faults and thus defeating the object of the training.

In addition, rising training costs and forgone revenues ate into dealers’ profits, prompting them to reduce their investment in tools and equipment, thereby limiting technicians’ overall effectiveness.

OEM strategies concerning the use of advanced diagnostic equipment were also vitiated by unanticipated secondary effects. One extremely costly device designed to improve diagnostic accuracy had a very low usage rate, despite being considered technically superb. The reason for its neglect was the fifteen minutes or so that it took to set it up—time that pressured technicians felt they could ill afford to spend. Moreover, a lack of initial training produced low familiarity, reinforcing underutilization which in turn reinforced low familiarity.

One OEM decided that in order to improve performance, it needed to identify where bottlenecks were occurring, and why. It applied Business Dynamics to model the repair performance of an actual dealership. It tested a scenario involving several new initiatives it had devised to fix the service problem by enhancing training and building technical and diagnostic support. The modeled initiatives produced some improvements, but they were limited and short-lived.


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Disappointing results can be reversed by addressing the powerful secondary effects inherent in the system
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Analyzing the model revealed that these disappointing results could be reversed by addressing the powerful secondary effects inherent in the system. Incentives to diagnose the real underlying problem with a vehicle were weak, since pay structures encouraged technicians to complete jobs as quickly as possible. In addition, initial improvements in the service process tended to get caught up at existing bottlenecks, sometimes even making them worse. Service advisers became overloaded and less effective; increased retail demand, generated by better short-term performance, compounded time pressures and prompted technician shortcuts; and new technicians hired to meet demand diluted the average level of experience.

The analysis also showed that the OEM support initiatives brought least benefit to those who needed them the most—the low-performing dealers. The rate of improvement for these dealers was a mere 4 percentage points, whereas their high-performing counterparts achieved an 11-point leap. Thus the aspiration to improve "fix-it-right" performance to 85 to 90 percent was still way beyond reach (Exhibit 1).

This is a little longer and includes some great graphic illustrations. Click to continue reading about overcoming powerful secondary effects (Scroll down to the first graphic to pick up where you left off.)

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