Are your strategy discussions stuck in an echo chamber?


Here is an excerpt from another “classic” article, written by Werner Rehm and Anurag Srivastava for the McKinsey Quarterly and published by McKinsey & Company. To read the complete article, check out others, learn more about the firm, and sign up for email alerts, please click here.

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Building a “market-momentum case”—based on external as well as internal data—can help executives allocate resources more effectively and identify new sources of value.
Sometimes, companies can inadvertently lose sight of the big picture when setting business strategies and targets. Line managers and senior executives hold overly optimistic views about projects and performance, and they use mostly internal data to develop plans around major product lines or individual customer segments or regions.As a result, they often end up with the familiar “hockey stick” plan—a projection that performance will sail upward after a brief early dip to account for up-front investment. This forecast does not reflect market realities, so the company consistently underperforms against the plan given market pressures, under-investment, or both.
A multinational industrial company learned this the hard way. Analysts and investors questioned the company’s ability to grow profitably in a market that was under significant price pressure from new entrants. Yet senior executives at the company continued to insist it was possible. They based their optimism on, among other things, market intelligence from line managers about customer preferences, and on a business plan that assumed efficiencies would compensate for decreased prices—and that margins would, therefore, not deteriorate.
Armed with this optimistic view, the company did not make big moves to capitalize on the advantages it held over new entrants. After several quarters in which the company missed its growth and margin targets, the share price dropped sharply. Senior management realized it had to revise both the company’s strategy and its communication to investors about its strategic targets.Clearly, there is no benefit to conducting strategy discussions in an echo chamber. Companies need to factor external perspectives into their resource-allocation conversations. And executives must be willing to challenge their own assumptions about whether the baselines and metrics they are using are the correct ones.

A full “market-momentum case” can help them do that. It provides a dispassionate forecast of where a company’s economics are going rather than where they have been. It demonstrates how any changes in end markets, competitors, prices, and other external variables will affect a company’s profits, cash flow, and valuation if no action is taken. The market-momentum case can serve as a solid starting point for strategy discussions; it can also serve as a useful benchmark against which to measure all business plans.

In our experience, when executives consider the market-momentum case alongside existing strategic plans, they typically end up in engaged conversations about how investments, targets for growth, and cost-reduction initiatives may complement one another and be successful—a far cry from the relative silence in the echo chamber.

Why the market-momentum case?

Consider the standard strategy-setting process: managers develop a “base case” that outlines financials and other targets over the next three to five years. To meet senior leaders’ and the board’s expectations, managers tell a hopeful story in the base case—demonstrating continual improvement in margins and financial impact, and minimizing inevitable obstacles to growth. After all, who ever got promoted by pushing a strategic plan that predicted declining margins and stagnation?

That is when the hockey sticks emerge. No one is explicitly discussing core questions, such as: Why do we believe the company can grow faster than the market in two years? Exactly which investments are supporting this optimistic outlook, and are these investments accurately reflected in the operating plan for the next 12 months? How might this base case be offset by pricing pressure? What’s more, managers’ biases toward overconfidence and overoptimism can affect not just strategic-planning discussions but also other complex business conversations about, for instance, acquisitions, cost transformations, and divestitures.  More forecasts, more hockey sticks.

A market-momentum case gives the company a holistic view of how profit and loss, the balance sheet, and corporate value will be affected if the company follows market growth, cost development, and pricing dynamics without taking any countervailing actions.

Executives often hesitate to present such an integrated economic case, fearing that it might result in a corporate valuation below the current market value of the company. This, however, is the point: if companies don’t make explicit strategic investments to increase value or take direct actions to improve operations, they may drift with the market and deteriorate quickly. A discussion that starts with the market-momentum case can help to ensure that alternatives are being debated, actions are being supported by investment, and everyone is aware of the risks and challenges.

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A strategic-planning process that systematically incorporates the “outside view” in near- and long-term planning can drive executives out of their echo chambers. Rather than being overoptimistic about company performance, they can use a market-momentum plan to increase internal transparency and boost the effectiveness of management planning.

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Here is a direct link to the complete article.

Werner Rehm is a partner in McKinsey’s New Jersey office, and Anurag Srivastava is a consultant in the New York office.

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