By Mark Chussil

“Even a Giant Can Learn to Run,” reported The New York Times on January 2, 2012. IBM is that running giant, and its CEO, Samuel Palmisano, is departing. He leaves behind a remarkable legacy of performance, which he attributes (to the extent one can sum up a decade running IBM in a brief newspaper article) to a guiding framework containing four questions. They are:

1. “Why would someone spend their money with you — so what is unique about you?”
2. “Why would somebody work for you?”
3. “Why would society allow you to operate in their defined geography — their country?”
4. “Why would somebody invest their money with you?”

Those who read my essays know that I am not often impressed by the mere accumulation of happy numbers, since happy numbers alone do not prove good strategic thinking. Mr. Palmisano asks good questions, but, with all due respect, those questions are not unique.

What I infer made them unique in Mr. Palmisano’s hands is that he evidently saw to it that they were answered honestly and thoughtfully, and that action was taken consistent with those answers.

In a business culture that venerates growth and size above all else, Mr. Palmisano’s IBM chose margins. He allowed IBM to fall to be the world’s second-largest information-technology company, after HP. He even sold solid businesses that no longer fit with IBM’s core, such as IBM’s personal computer operation, a business with nearly $20 billion in annual revenue, reasoning that it would get the best price when it’s performing well . This is MBA 101 in theory, but how often do you see that theory in practice? The thing is, it’s a good theory.

And that’s why I congratulate Mr. Palmisano and IBM. There are as many ways to accumulate happy numbers as there are ways to be lucky, which is to say there are a lot of ways. But applying the diligence and discipline not only to ask good questions but also to answer them well, and to act on the answers, makes those happy numbers well-deserved.

by Mark Chussil

A few weeks ago Netflix raised its prices enough for people to notice. (It also split its DVD-rental and streaming-video services into two companies, Qwikster and Netflix, but it abandoned that move.) They lost 800,000 subscribers, they gained outrage and uproar, and their stock price fell sharply.

Assessment of their pricing strategy: Wrong. Or not. Let’s take a look. Then we’ll find we’ve answered the wrong question, which will lead us to the right one.

Disclaimers. I subscribe to Netflix. I don’t have special knowledge of the company and I haven’t talked to its strategists. I haven’t formally analyzed their strategy. On the other hand, we’re merely going to speculate, so we can relax our standards. Moreover, I have analyzed many other strategies, and one learns a thing or two. End of disclaimers.

Netflix raised their prices. Bad move.

1. They suffered a non-trivial loss of revenue. It amounts to something on the order of $20 or $30 million per quarter. That could sap profits precisely when they need the money to invest in wave-of-the-future streaming.
2. They lost customers that could have migrated to streaming. Those customers now become happy hunting for salivating competitors.
3. They made themselves vulnerable in their bread-and-butter business. As of this writing, Blockbuster’s website launches with an unsubtle ad specifically targeting disgruntled Netflix rental customers. (For more on Blockbuster and mistakes, see It’s Working!)
4. It was an awfully big price boost. Don’t they know there’s a bad economy out there and their customers are hurting? Netflix looks cold and out of touch.
5. The negative publicity might dissuade new customers from giving Netflix a try. They lose not only the 800,000 but also some portion of the people who would oth-erwise have signed up in the future.
6. Loyalty is essential in subscription-based markets, especially when switching costs are low. It’s generally cheaper to keep a customer than to get a customer, and a customer who leaves in a huff may not soon return.
7. That Qwikster thing was not customer-friendly; people with both DVD and streaming services would have to manage two accounts. If Netflix was tone-deaf enough to propose that, did they really know what they were doing with their prices?

Upstanding strategists, a question

Those are some pretty strong arguments, if I did say so myself. It doesn’t look good for Netflix. But we, being upstanding strategists, know we must consider scenarios and decisions from all angles before we judge.

So, let’s ask a question that I have found ranks among the best an upstanding strategist can ask in his or her career of critical thinking and rigorous decision-making. Let’s ask why a smart person would have done what initially appears not-smart. After all, the folks at Netflix are smart and they want to succeed. They set out to do something smart, not something not-smart.

Netflix raised their prices. Good move.

1. Companies often boost prices when costs go up. Netflix’s costs are going up. Their streaming service requires lots of licensed “content” (movies and TV shows). Those licenses cost more and more as content owners see subscribers growing and realize the value of their content.
2. 800,000 customers sounds like a lot. (Well, it is.) Still, it’s only 3.25% of Netflix’s 24.6 million customers in the USA, as of Q2 2011, and each quarter Netflix adds more than twice as many as the 800,000 they lost. (Key data here came from Business Insider.)
3. Netflix was realistic and had done its homework. They expected to lose some subscribers when they raised their prices. They even took pains to explain their price move to subscribers; how many other companies do that?
4. Pretty much by definition, many or most customers who leave after a price increase are those most sensitive to price and most likely to buy the least-expensive subscription plan. The increase in profits from higher prices could outweigh what those lost customers would cost.
5. Netflix may want or need to amass cash for the major investments it faces. Its strategists know well that much of their market will switch to streaming, and they surely fear a visit from the ghost of slow-to-adapt Blockbuster.
6. Netflix made clear that it is committed to streaming and to the long-term health of its company. Those are important signals to competitors and to investors.
7. It is arguably more important to be a clear market leader in streaming video than it is in DVD rentals. Netflix may want to incent its DVD customers to move to streaming so that Netflix stays in front. (See also Room for One.)

The wrong question

Did you notice the wrongness of the question we implicitly asked? We debated as though Netflix’s strategy had been to lose 800,000 subscribers. But losing subscribers wasn’t their strategy; it was a consequence of their strategy. Perhaps an intended consequence, perhaps unintended; perhaps expected, perhaps a surprise; but not their strategy.

That leads us to the questions we should ask: what did Netflix’s leaders want to accomplish, and, given that objective, did they choose a good strategy?

The right answers

It seems that Netflix wants to be strong in streaming without exiting rentals. Both markets are viable, and it makes sense to me that Netflix would want to be in both. Why forgo the wave of the future? Why turn their back on a prosperous business that can thrive for years to come? I’m willing to accept be-strong-and-prosper as their objective.

My short answer to the second question, did Netflix choose a good strategy, is not just refreshingly brief; it is also admirably accurate. It is this: I don’t know. As I said, I haven’t been inside the company and I haven’t spoken with their strategists.

This is brief and accurate too: whether they chose a good strategy is knowable.

It is not knowable by citing their loss of 800,000 subscribers and a great deal of market valuation. Those are outcomes, and even good strategies get bad outcomes from time to time. Plus, many strategies require more than a few weeks to achieve their desired effects. (See also Who Did Best?)

Whether Netflix chose a good strategy is knowable because it is analyzable. I know it is because I’ve performed such analyses on other businesses, and because other people have too.

Such an analysis for Netflix would not look like gap analysis or financial analysis (too narrow) or like trend analysis or benchmarks (little or no relevant past). It would not rely on anecdotes or arbitrary performance targets. (See also All About Models.)

Rather, it would delve into exactly the points, all of them, raised by the fourteen reasons why Netflix was wrong, or not.

Judgment

Dear reader, if you are a pundit or guru who wants to pronounce lurid and/or definitive judgment on Netflix’s goodness and smartness, then you must be sorely disappointed in this essay. I’m afraid it’s not going to get any better for you. But if you are not such a pundit or guru then you will, I hope, join me in three conclusions.

First, we cannot, and therefore should not, gauge the rightness or wrongness of a strategy merely by noticing whether we feel joy at its outcomes at this very moment. We should gauge the quality of the strategists’ decision and decision-making.

Second, it is useful to debate the rightness or wrongness of a strategy. Debate surfaces and clarifies important issues to analyze.

And finally, whether Netflix has gone vile or smile (sorry, my best rhyme at this time), they deserve kudos for their efforts to avoid the pitfalls of those who came before. Think about this: Blockbuster could have been Netflix if only they’d strategized differently.

Update, January 26, 2012. Netflix reported 4th quarter 2011 results. Profits beat “expectations,” despite dropping 13.5%. Its subscriber base grew and sales went up 47%. Its stock surged, but perhaps for reasons not related to its strategy.  See CNNMoney, “What’s behind Netflix’s 20% spike?” So, with the passage of a near eternity — oh, six months or so — did Netflix go vile?

Update, January 26, 2012. See also “Netflix Will Rebound Faster than You Think,” by Annika Olson and Eddie Yoon of The Cambridge Group, writing in the HBR Blog Network.

Update, December 25, 2011. Netflix CEO Reed Hastings, speaking about the Qwikster move, was quoted by CNN. “‘We berate ourselves tremendously for that lack of insight because it didn’t need to be that way,’” CEO Reed Hastings admitted recently at a conference. “But you know, in three or five years, we aren’t going to remember it. It’s going to be, `’Did we succeed at streaming?”‘” Worth noting too: CNN pronounced Netflix’s move “dumb” purely on the basis of the short-term loss of subscribers and value in the stock price. Hastings may yet turn out to be wrong, but he’s obviously playing for the long term. For more on judging strategies, which isn’t such an easy business, see Who Did Best?.

Update, November 22, 2011. For more on the financial and competitive maze Netflix has to navigate, see “Netflix warns of losses for all of 2012.”

Kudos to Sharon Begley, Newsweek’s excellent science columnist, for her article “Don’t Just ‘Do Something’” in the June 21, 2010, issue of the magazine.

Tongue in cheek, Ms. Begley begins “Scientists are such spoilsports, always insisting on gathering data on the likely effects of a strategy before implementing it.” She then focuses on the oil spill and the pressure politicians feel (I add: pressure that perhaps they bring on themselves?) to do something even if there’s no evidence that the something-to-be-done will help. The pressure they feel to do something can prevail even if there is evidence that the something will make things worse. Apparently we the people believe that bad action is better than no action at all. If we didn’t believe that, we wouldn’t demand that politicians act. Not unlike, perhaps, demanding that doctors prescribe antibiotics to treat a virus.

Businesspeople feel the same pressure, of course. We feel the pressure to beat targets. We feel the pressure to turn things around. We feel the pressure to make our mark and show we’re in charge. We fall into a do-something trap.

I’ve seen it often in business war games. When given an opportunity to change their strategies, managers usually do so (and almost always do so if they’re taking over from another group of managers). They usually don’t stick with a previous strategy decision, whether or not it seems to be working. And those changed strategies often subtract value. How do I know? By simulating their businesses’ performance with and without the strategy changes.

I’ve seen it also in the tens of millions of strategy simulations I’ve run (using ACS’ patent-pending strategy decision tests) in a pricing tournament on which I’ve previously reported. Nearly 300 strategists have contributed pricing strategies to the tournament. Each person’s overall pricing strategy could include 0, 1, or 2 changes in strategy over time. About 28% of the strategists made 0 changes, 25% made 1 change, and 47% made 2 changes. The 47% making 2 changes performed slightly worse than the other groups. I am not saying that changing strategies necessarily hurts performance. I am saying that merely changing strategies — doing something when we have the chance — doesn’t necessarily help performance.

The question, of course, then becomes how can we know if changing course will help or hurt. That, Ms. Begley says, is what science is for. Where we don’t have established science, I’d add that it’s worth testing a strategy change in a safe environment before you act. And the first do something you should do is to not assume that doing something will make things better.

Further reading: A Dark and Stormy Night, Gross Galactic Product, It’s Working!, The Model Whisperer,  What You Pay For.

Kudos to Abercrombie for not slashing prices in the dismal retail climate. (“Abercrombie to Stick to Full Prices, Despite Bleak Outlook,” The Wall Street Journal, November 14, 2008.) Their sales are down – then again, whose aren’t? — but their margins are strong. Competitors that are cutting prices to maintain sales are suffering greatly reduced margins. As Abercrombie recognizes, today’s reduced margins are not the only casualty of price cuts; tomorrow’s reduced brand equity and reputation will take a toll too. Note, by the way, that we don’t know what the outcome of Abercrombie’s decision will be, though we predict it will be good. All we can do regarding them, and all anyone can do with any prediction, is to laud the quality of their decision.

Further reading: What You Pay For, Alignment, Making Competitors Intelligent.

Abercrombie update, May 17 2009. The Journal reported After Big Loss, Abercrombie to Cut Prices. Abercrombie has chosen to implement “meaningful reductions” in price. The result so far is that the rate of decline in Abercrombie’s sales has slowed: sales fell 22% in April, less than the decline in March. Meanwhile, gross margin dropped 3.5 percentage points. A good move? Depends on what you want, of course, sales or margin. And it depends on whether you believe that the price cut now will affect their brand and pricing power later. Apparently Abercrombie executives are concerned about downstream effects too: they concentrated the price cuts on just two of their brands.

Kudos to Pure Digital for their Flip line of picket-size camcorders. (“Gadget of the Stars” by N’Gai Croal, Newsweek, December 15, 2008.) They thought broadly and boldly, going from making disposable digital still cameras for drugstores and camera shops to a 32% share – versus Canon’s 10% and Sony’s 8% – in Flash-based camcorders. Not bad for a company that started in 2001. Note also how Pure Digital thinks differently from at least one of its competitors. According to Newsweek, Audiovox “plans more-aggressive marketing and pricing. ‘In this economy, people are looking for value,’ says [senior VP Ralph] Etna.” Meanwhile, Pure Digital’s CEO Jonathan Kaplan says “‘We want to show the world that we can innovate with tech and fun.’” (To be fair, that’s one sentence from Audiovox. Your voluble author remembers giving 45-minute interviews that were condensed into a single sentence.)

Further reading: You’ve Got the Data. Now What?, You Say You Want a Revolution, Exalted Numbers.

Kudos to Mayor Oh Se-hoon of Seoul for… well, we’ll just include several quotations from him in his interview with Newsweek Chairman Richard M. Smith (“A Young Mayor Pushes Reform,” Newsweek, December 15, 2008). “‘Korea heavily depends on trade with the outside world, and the products we export with a touch of culture will be sold at a more expensive price.’” “‘We already have 30,000 design students coming out of school every year. … Our goal is to have people say that if you want to see the latest design trend, you should go to Seoul.’” About making Seoul a global and business-friendly city: “‘We want to be friendly to foreigners, and that is probably the best advantage we can have.’” About being judged: “‘If I have created a working environment where public officials try new things, I should be recognized as a successful mayor.’”

Cost-cutters and bailers-out: notice the emphasis on investment, creativity, and vision. How different that is from budgets, giving the customer what they “ask for,” and defining success as a good quarter. Abercrombie, Pure Digital, and Seoul have a lot in common. Would you invest in them, or in their competitors? Further reading: The Good, the Bad, and the Lucky.

One of my favorite websites (at least until November 4) is fivethirtyeight.com (“Electoral Projections Done Right”). Named for the number of electors in the Electoral College, the site cleverly combines polling data with thousands of scenario simulations to assess what might happen in the presidential election now underway in the United States. It is testimony to the combined power of creativity, rigor, and computer power. It is to conventional projections what Microsoft Excel is to a pocket calculator.

(If you like what you see at fivethirtyeight.com, take a look at ACS’ Decision Tournaments™ and Robert Axelrod‘s book The Evolution of Cooperation.)

Those of you who have visited ACS’ new website, whatifyourstrategy.com, deserve to know who deserves the credit for it: the fine folks at Substance, Inc. They took lofty ideas and ambitious vision and brought them to electronic life. Substance did a great job, and we thank them.

Where did the ideas for our new website come from? I credit my colleague Mark Jacobs. We at ACS practiced what Mark preached in his blog post What are you?, and we thought through who we are. Thank you, Mark.

The Wall Street Journal wrote on September 23, 2008, about Honda’s flexible production facilities. It can take GM or Ford weeks or months, and many millions of dollars, to modify a plant to build a different model. It can take Honda’s plant in East Liberty, Ohio, as little as five minutes to switch from building Civic compacts to CR-V crossovers.

There are many advantages to that flexibility, and the article describes some of them. As a “what if your strategy” exercise for the reader, see how many you can imagine. (For practice, think about bathtubs.) Notice that not all of the benefits are about production. There are as many benefits for business strategy.

When I was an undergraduate at Yale, I listened to Avalon Professor of the History of Science Derek de Solla Price (1922-1983) talk about knowledge. As I remember through the fog of decades, he said that the best insights to be gotten from science would come from looking across fields (silos, if you will). It occurs to me that that’s what Honda has done, intentionally or not. Mass-production factories are hard-wired, which is nirvana for economies of scale and anathema for adaptability. Flexible factories are a stretch for a person who thinks in terms of mass production, and they are a perfectly natural concept to a computer scientist, for whom hard-wiring is awful. Instead of Microsoft Word, can you imagine Microsoft Poet, a processor for words that rhyme, and Microsoft Prose, a processor for words that don’t?

Kudos to Honda, to others who use flexible factories, and to those who design flexible factories.

An honorable mention to Chrysler. On September 24, the Journal wrote that Chrysler is moving its electric cars to market quickly “by relying on outside suppliers for many … key components. That is a big change from the auto industry’s traditional approach.”

Much of what we read and hear in the media is about averages, trends, and “the market.” When we see such information, it’s natural to worry that they know something I don’t. It’s natural to fear being left behind, being left high and dry. Welcome to the great (as in large) masses. Here’s your uniform. Don’t worry, one size fits all.

There may be wisdom in crowds and safety in numbers, but there’s not much inspiration in a herd or thought in groupthink.

The innovator, the leader, and the winner don’t yell “Quick, do what everyone else is doing!” They do something different.

To be fair, doing something different isn’t a sufficient condition for success. If it were, my idea for an espresso tap, alongside the hot and cold water, would have made me a rich man. Do something different that’s good.

And so let us here congratulate the companies that are doing something different and good. The companies that defy the averages, buck the trends, make their markets. The companies that make their success even in tough conditions. Apple is a perennial favorite, with designs and foresight that behemoths never seem to beat. Singapore Airlines, priced high and making money with a superior service when most airlines think of nothing but cost. Method, revolutionizing home-cleaning products. And which company do you admire more, General Motors  ($181 billion in revenue) or Porsche ($7 billion in revenue)?

It’s your turn. Which companies would you nominate as counterpoints, mavericks, and exemplars of good-different? Let us know your favorite(s) and why they make your list.