How do companies counter and mange the forces which are so structured that they naturally have profit reducing tendencies? Profit here is the economic profit i.e. what is left over from the net operating profit after reducing the cost of capital. For it is this economic profit that truly creates value in businesses. What we are looking to analyze today is – what separates consistent value creators from those which are not able to? According to a recent McKinsey Company study “…when you think about it, though, overcoming the profit-depleting effects of market forces is the essence of good strategy—what separates winners from losers, headline makers from also-rans. A focus on the presence, absence, or possibility of market-beating value creation should therefore help transform any discussion of strategy from something vague and conceptual into something specific and concrete.”
The study found that value creation tends to be undemocratic.
The study notes that, “Economic profit is distributed in a far from democratic way. The 60 percent of companies in the middle three quintiles generate a little over $29 billion in economic profit, or around $17 million each—only 10 percent of the total pie. This share is dwarfed by the $677 billion generated in the top quintile, where each company creates almost 70 times more economic profit than do companies in the middle three, and by the nearly $411 billion destroyed in the bottom quintile.”
The behavior of the components that create economic profits has been analyzed in the study as follows:
The research also shows that good companies generally do well in so called not so attractive industries. So how do these companies actually counter the value declining forces? i.e. how are the strategies formulated, adopted and executed to enable companies to handle these forces successfully? These companies according to another Mckinsey Company article do justice to the building blocks of strategy.
Explaining the framework the article says that these companies have a “…..deep insight into the starting position of the company: where and why it creates—or destroys—value (diagnose). Executives also need a point of view on how the future may unfold (forecast). By combining insights into a company’s starting position with a perspective on the future, the company can develop and explore alternative ways to win (search) and ultimately decide which alternative to pursue (choose). With the strategy selected, the company needs to create an action plan and reallocate resources to deliver it (commit). ”
The article goes on to elaborate the points in the framework providing a number of other insights which the readers will find interesting intriguing and useful.
Source: The strategic yardstick you can’t afford to ignore, Mastering the building blocks of strategy
GR Advisory & Training 